Mortgage Delinquency Rates Record Low – Is This the Calm Before the Debt Storm?

The U.S. housing market partied hard in 2021 and early 2022, as record-low mortgage rates and pandemic-induced demand set off vicious bidding wars and sent home prices soaring. 

The fun didn’t last. The Federal Reserve began raising interest rates in March 2022, turning off the easy-money spigot that fueled the boom. By the fall, homebuyer demand cratered and price cuts replaced over-asking bids. Housing experts polled by Reuters expect home prices to drop by 12% before bottoming out, giving up about a third of the 40% gain logged since 2020. This drop is one of several reasons most economists expect the U.S. to tip into recession in 2023.

More troubling is the prospect of a sharp increase in mortgage delinquencies. Bad mortgage loans tend to increase when the housing market turns down and unemployment rises. The last time housing prices declined significantly, in the late 2000s, mortgage delinquencies hit historic highs and helped precipitate a deep, prolonged recession. 

Are we due for a repeat?

Mortgage Delinquency Rates Sit at 1.86% — the Lowest Since Q3 2006

According to the Federal Reserve Bank of St. Louis, the delinquency rate on U.S. single-family mortgages was 1.86% in Q3 2022, the most recent period we have data for.

That’s the lowest level since Q3 2006 and close to the historic low of 1.41% set in Q1 2005. 

Looking at the Fed’s chart, it’s hard not to notice what happened between 2006 and 2022. From late 2006 through the end of the decade, the single-family mortgage delinquency soared. It peaked at 11.48% in Q1 2010 and remained above 10% through 2012. From Q4 2009 to Q1 2013, at least one of every 10 active single-family residential mortgages was in distress.

Put another way, at least one in 10 American homeowners was in danger of losing their home during this period. And millions did.

Mortgage Debt Has Grown Since 2013 and Is Higher Than It Was in 2008

The single-family mortgage delinquency rate took the better part of a decade to normalize. It didn’t reach its pre-housing crisis equilibrium (under 2.5%) until Q3 2019, just months before the onset of the COVID-19 pandemic pushed it higher again.

But by 2013, homebuyers had regained some of the confidence lost during the housing crisis and banks were slowly but surely loosening their lending standards once more. Outstanding mortgage debt began climbing. In 2016, total U.S. mortgage debt passed the previous all-time high of about $14 trillion set in 2008. By 2021, homeowners collectively owed more than $18 trillion on commercial mortgages.

It’s true that conditions are much different now than in 2008, when the economy was mired in recession, homeowners’ average net worth was much lower, and the global financial system faced its biggest test since the Great Depression. Today, unemployment remains low (if likely to rise in 2023), personal balance sheets remain strong, and the global financial system shows no outward signs of serious strain.

But every new mortgage loan is another potential delinquency, and the more borrowers owe relative to their income and assets, the likelier they are to fall behind on their payments. Should economic conditions and household balance sheets deteriorate further, 2008 might not seem so foreign.

Meanwhile, U.S Credit Card Debt Is Nearing All-Time Highs…

A parallel increase in Americans’ total and per-capita credit card debt adds cause for concern. According to our data, total U.S. credit card debt hit $930 billion in Q3 2022, up from less than $800 billion in Q1 2021. 

Total U.S. credit card debt has already surpassed its 2008 high, though there were fewer Americans and fewer credit cards back then. It’s likely to surpass the all-time high set in 2019 sometime this year, if it hasn’t already.

The credit card delinquency rate remains low for now, but as with the mortgage delinquency rate, most analysts expect it to rise in 2023 and beyond. Indeed, the two measures are closely correlated because both are proxies for financial distress. Though the typical homeowner defaults on their credit cards before defaulting on their mortgage, more debt overall increases the risk of a spiral that ultimately results in foreclosure.

…While the Average Person Has Lost $16,000 in Savings

Finally, and perhaps most worrying of all, the U.S. personal savings rate has collapsed since early 2021. The average household lost $15,990.59 in savings between March 2021 and October 2022. As pandemic stimulus dried up and prices soared, many went from having months of income stashed in the bank to living paycheck to paycheck once more.

Part of the trend can be explained by mean reversion. That is, saving rates spiked during the first year of the COVID-19 pandemic and have come down as people spent through their extra cash.

But inflation is a major driver of the personal savings collapse as well — and a major threat to Americans’ collective ability to pay their bills in 2023 and beyond. Cashflow-negative households can’t pay their mortgages, car notes, and credit cards out of savings forever. And while the inflation rate appears to have peaked for now, real wage growth is likely to remain negative as the economy softens and annual price increases remain high by historical standards.

The Perfect Storm for Mortgage Delinquencies?

The best — really, only — recent historical comparison for our present situation is the late-2000s housing crisis, and it’s not a very apt comparison.

Though weakening, the economy is stronger today than back then. Household balance sheets are in better shape, despite falling personal savings. Inflation is much higher, but so are incomes.

Still, you don’t have to be a pessimist to wonder whether already-apparent housing market weakness will spill over into the broader economy, precipitate a spike in unemployment, and spur a wave of mortgage delinquencies and foreclosures like we saw back then.

Mortgage Originations Have Dropped in the Past Year

The total quarterly value of U.S. mortgage originations dropped from about $235 billion to about $170 billion in the year ending June 30, 2022. By then, the drop in homebuyer demand was already apparent.

It has only worsened in the months since. Fewer people are in the market for new homes, listed homes are sitting on the market for longer, and homes that do eventually sell are much more likely to sell for below asking price.

In the long run, this is probably a good thing for the U.S. housing market. The Federal Reserve Bank of Atlanta’s Home Ownership Affordability Monitor, which measures relative affordability in U.S. single-family residential real estate, is well below the previous all-time low set in 2007. Eye-watering price increases during 2021 and early 2022 put homeownership out of reach for many Americans, so modest price declines would help bring the market back into a more balanced state.

But in the short term, falling home prices are likely to push the mortgage delinquency rate up. Many homeowners who bought in the past 24 months have little to no equity. Some are already underwater, meaning they owe more on their mortgages than their homes are worth. Further home value declines will increase the percentage of underwater borrowers, who — as we saw during the late-2000s housing crisis — often walk away from their homes rather than selling them because they have no hope of repaying the bank.

Interest Rates Have Increased in the Past Year

The decline in mortgage originations (and in home prices writ large) is largely down to rising mortgage interest rates. In late 2021, a new 30-year fixed rate mortgage cost 3% to 3.25% per year with no rate-reducing points needed. Today, that same mortgage costs 6.5% if you’re lucky.

Some homebuyers have no choice but to move, of course. They’re relocating for work or family reasons, they desperately need to upsize or downsize, or they can simply no longer tolerate their current place for whatever reason. To maximize their purchasing power, they’re turning to an appealing but risky alternative to fixed rate mortgages: adjustable rate mortgages, or ARMs, which were last so popular during the mid-2000s housing boom.

We know what happened next. Many analysts are worried about a rerun in the coming years. 

See, ARMs are great for the first few years — typically 3 to 7 — when the initial rate is fixed at a level well below the current 30-year fixed rate mortgage benchmark. (5-year initial ARM rates hovered between 5% and 5.5% in January 2023, compared with 6.25% to 7% for 30-year fixed rates.) But once that initial period ends, the rate adjusts upward, often to a level above the prevailing 30-year fixed mortgage rate. Unless you plan to sell or refinance before this happens, an ARM could cost you more than a plain-vanilla mortgage.

It’ll take years for the downsides of the current ARM mini-boom to become clear, and this factor alone won’t lead to a huge spike in delinquencies. Banks are smarter about who they lend to today than they were back in the mid-2000s, when millions of home loans went out the door with little due diligence. Still, many buyers who don’t fully understand the ARMs they took out in 2022 and 2023 will struggle when the bill comes due in 2025 or 2026.

Final Word: Where Mortgage Delinquency Rates Headed From Here?

Is the present lull in mortgage delinquencies just the calm before the storm? Or, in spite of what sure seem like stiffening headwinds, will the widely expected wave of delinquencies and foreclosures turn out to be more of a ripple?

After crunching the latest data on inflation, home prices, personal savings, and other household debts, I’m in the “ripple” camp. It seems clear that the mortgage delinquency rate will increase in 2023, and I’d bet it continues to rise in 2024 as well before leveling off. But we’re talking about a modest, gradual increase that remains within the historical prepandemic range, between 2% and 3%. 

My thinking is this. Inflation has peaked, at least in the short term, and the Federal Reserve is close to the end of its tightening cycle. The U.S. Treasury bond market, which plays a critical role in setting mortgage rates and which is inherently forward-looking, has already priced in declines in price rises (inflation) and in the benchmark federal funds rate, which many expect the Fed to begin cutting later this year. Less upward pressure on mortgage rates — indeed, I expect mortgage rates to continue to fall in 2023 — means less downward pressure on home prices and more financial breathing room for new homebuyers.

Yes, we’ll probably tip into a proper recession later in 2023. Which is why I expect mortgage delinquencies to rise a bit in the near term. But I don’t expect the sky to fall, nor anything outside the norm of a typical recession. Boring, perhaps, but surely a relief for millions of recent homebuyers on a fiscal knife’s edge.