Following the rapid contraction in U.S. economic activity because of the outbreak of COVID-19, millions of Americans took advantage of payment suspension and mortgage forbearance programs. At the peak in June 2020, approximately 4.3 million homeowners were in forbearance plans. A year into the pandemic, and that number has declined to approximately 2.3 million homeowners. While this number will likely continue to fall as the labor market rebounds further, concerns remain that the expiration of emergency protections will unleash a flood of foreclosures similar to the Great Recession. Yet, our analysis shows that this time, the record levels of equity enjoyed by many homeowners will help limit the number of foreclosures. In fact, if distressed homeowners are required to resolve delinquency, involuntary sales, while still distressing for those involved, are much more likely than foreclosures given the likelihood of significant equity buffers.

“Forbearance is not a permanent solution to housing distress and eventually the emergency protections will expire, but because so many homeowners have a considerable equity buffer, we’re more likely to see a foreclosure trickle than a tsunami.”

Not All Delinquencies Lead to Foreclosure

An adverse economic shock may lead a homeowner to become delinquent on paying their mortgage and eventually lead to serious delinquency (a borrower not making payments on their mortgage in the last 90 days), but not every seriously delinquent homeowner will go into foreclosure. The share of homeowners that transition from serious delinquency to foreclosure can be estimated using the transition rate – the ratio of foreclosure initiations in one quarter relative to the number of seriously delinquent mortgages in the preceding quarter.

Borrowers who have little to no equity are more likely to transition from serious delinquency to foreclosure. Positive house price appreciation, however, increases home equity and thus helps prevent foreclosure. Our analysis shows that in the post-Great Recession period, a one percentage point increase in annual house price appreciation results in a 0.33 percentage point decline in the transition rate, or 6,700 fewer foreclosures when all other factors remain unchanged.

Equity Helps Prevent Foreclosure

The share of homeowners who transition from serious delinquency to foreclosure averaged 22 percent from the end of the Great Recession until the end of 2019. In the third quarter of 2020, transition rates fell to less than 1 percent due to the emergency protections. Yet, given the historically high levels of home equity today, our analysis suggests that, without emergency protections, transition rates in the third quarter of 2020 would have been approximately 22 percent, in line with the pre-pandemic average.

To demonstrate the power of equity, the number of foreclosure starts peaked at nearly 733,000 at the height of the foreclosure crisis in the third quarter of 2009. At the time, house prices had declined by nearly 11 percent compared with a year earlier. Had all other factors remained unchanged in 2009, except annual house price appreciation was replaced with the positive 11 percent year-over-year rate from the fourth quarter of 2020, there would have been 34 percent fewer foreclosure starts, according to our analysis. Over 249,000 foreclosure starts may have been prevented in that quarter alone. With enough equity, a homeowner has the option of selling the home, an option that doesn’t exist for a homeowner in a negative equity position.

Indeed, this time it’s different. House price appreciation is expected to remain positive, if not accelerate, due to the ongoing supply and demand imbalance in the housing market. Forbearance is not a permanent solution to housing distress and eventually the emergency protections will expire, but because so many homeowners have a considerable equity buffer, we’re more likely to see a foreclosure trickle than a tsunami.

Ksenia Potapov contributed to this blog post.