Mortgage Defaults, Delinquencies, and What the Data Means

Story summary: Mortgage defaults and delinquencies were both down in January 2012, compared to the previous month. The year-over-year delinquency rate dropped by more than 10%. Foreclosure starts were up last month, but this is to be expected as the banks begin to process foreclosures more rapidly.

Mortgage Delinquencies, January 2012

You can tell a lot about the future of the housing market by looking at mortgage delinquency and foreclosure trends. An uptick in the number of defaulting homeowners generally suggests a swelling tide of foreclosures down the road. This is exactly what we don’t need right now, given the supply overhang I wrote about on Monday. In the absence of strong demand, this kind of trend puts downward pressure on home prices and stalls recovery.

A drop in delinquencies, on the other hand, can be taken as a good sign. At least, when it happens over a long enough period of time to be statistically significant. And that’s what we have in the latest report released by Lender Processing Services (LPS), a data and technology firm that serves the mortgage industry. Roughly half of all U.S. home loans are serviced with LPS’ technology products. According to their report, which contains data through the end of January 2011, there has been a 10.5% decrease in mortgage delinquencies over the last year. And that bodes well for the future of the housing market. The distant future, anyway.

Delinquencies, Defaults and Starts – What Does It All Mean?

In order to understand what all of this means to the housing market, we must keep the terminology sorted out. In particular, it’s important to understand the distinction between these three terms:

  • Mortgage Delinquencies — These are homeowners who have fallen behind on their monthly payments. It generally refers to people who are at least 30 days, or one payment, past due. (Technically, you are delinquent one day after a missed payment. But most lenders allow a grace period of up to 30 days.) These are homes that have not yet fallen into foreclosure, though many people who reach this stage of delinquency do end up in foreclosure eventually.
  • Mortgage Defaults — This is when the homeowner has missed three or more payments on the loan. At this point, the homeowner is at least 90 days delinquent on the mortgage. This is a key stage in the process, because it’s the point at which most lenders will start the foreclosure process (see next item). Note: Foreclosure laws and proceedings vary by state. This time line is not set in stone.
  • Foreclosure Starts — This is when the bank / lender has actually initiated the foreclosure proceedings, usually by filing a notice of foreclosure with local officials.

I’ve put these terms in chronological order. The homeowner becomes delinquent after missing a payment. If the delinquency continues for three or more payments, he or she is said to be in default on the loan. A foreclosure start occurs when the lender initiates the process through which they will repossess and resell the home.

Delinquencies and defaults were both down in January, while foreclosure starts were up. But there’s a very good reason the starts are rising. It’s to be expected really, given the recent events in the lending industry. What’s more, foreclosure starts will likely rise again next month, and possibly the month after that. But it’s not the end of the world. In fact, it may just be the beginning of a long-delayed recovery.

Many in the media have missed the key piece of data contained in this report. Their headlines tell of the “rise in foreclosure starts,” while all but ignoring the year-over-year drop in delinquencies. There was also a drop in mortgage defaults, as reported by S&P recently.

Rise in Foreclosure Starts Inevitable After “Big Bank Settlement”

Earlier this month, the federal government reached an agreement with the largest mortgage lenders in the country, over the alleged abuses that are now collectively known as “robo-signing.” In short, the five banks will pay around $26 billion to end the nationwide investigation into their foreclosure-processing practices. This will allow a return to business as usual on the foreclosure front. It will also very likely lead to a rise in the number of home seizures, as we move further into 2012.

The Washington Post recently stated that the foreclosure settlement “may result in a wave of home seizures, inflicting short-term pain on delinquent U.S. borrowers while making a long-term housing recovery more likely.”

Now, the banks can process foreclosure more efficiently. This might seem like a bad thing. The machine that pulls homes out from under people is once more running at full speed. In many cases, however, a foreclosure filing is inevitable. Like when a homeowner is several months into default and has no intention of resolving the debt. The longer it drags out, the more it hurts the housing market. It adds to the so-called shadow inventory of distressed properties. It keeps supply and demand in a state of imbalance. It prevents appreciation and delays housing recovery at the local level.

The efficient resale of distressed properties is critical to our nation’s housing recovery. And the foreclosure settlement between the government and the big banks is a step in that direction — regardless of how we feel about it on a personal level.