The decline in foreclosures and short sales is one of the best signs of how much progress the housing recovery has made. But it's also contributing to a dearth of housing inventory that's constricting the market.
The situation is further complicating the prospects for both home buyers already feeling the pinch of a tight market for mortgage credit and lenders that need purchase activity to supplant refinancing once interest rates rise.
"There are less and less homeowners going delinquent and less and less homeowners going into default," said Rick Sharga, an executive vice president at Auction.com. "While that is good for the overall market, it does suggest that credit is tighter than it has ever been," and qualified borrowers are not getting loans. It also makes for scarce inventory for investors seeking to buy foreclosure and real estate owned properties.
Vintages of mortgages originated after 2009 have shown very good performance. The serious delinquency rate of Fannie Mae conventional loans has dropped 20 consecutive quarters since the first quarter of 2010, when the percentage of loan 90 days or more past due was 5.5%.
In the first quarter of 2015, Fannie's single-family portfolio had a 1.8% serious delinquency rate. This decline reflects credit overlays as well as loan modifications and other home retention efforts. Prior to the housing bust, it was normal for Fannie to have a 4.5% serious delinquency rate.
"If credit standards stay the way they are and nothing else changes from an economic standpoint, we could wind up with historically low levels of loans in default or delinquency," Sharga said.
However, tight credit has consequences. It clears the market of homebuyers who are most likely to default and pushes more people to rent over extended periods, according to John Finerty, an attorney at Michael Best & Friedrich in Milwaukee.
The volume of completed foreclosures peaked in the third quarter of 2010 at about 290,000 REO sales, according to housing data provider RealtyTrac. At the same time, the inventory of existing homes for sale was approximately 3.45 million units, which represents an 11.3 months' supply, according to the National Association of Realtors. Since then, foreclosures have fallen 72%, to nearly 83,000 in the first quarter of 2015, while housing inventory sits at less than 2 million units, or a 4.63-month supply.
Meanwhile, more than 10 million Americans are trapped in their homes due to negative equity because they don't have enough equity to sell their home and buy another. That is "one of the big reasons we are not seeing more homes available for sale," Sharga said. Auction.com is based in Irvine, Calif.
Despite the significant rate of underwater borrowers, short sales are also on the decline. After peaking at about 109,000 in the third quarter of 2012, short sales numbered fewer than 24,000 in the first quarter of this year, a 78% drop, according to data from Hope Now, a consortium of mortgage servicers and other industry stakeholders.
One reason for the drop in short sales is that lenders are finding that as home prices rise, they can get a better outcome through foreclosure auctions or REO sales. And REO sales are quicker than short sales. "Short-sale buyers seem to be more impatient now than ever waiting for short-sale approval, so many offers are withdrawn," Finerty said via email.
Another issue is that underwater homeowners are reluctant to do short sales after the Mortgage Forgiveness Debt Relief Act was allowed to expire at the end of 2014. The law, which eliminates the tax penalty for canceled mortgage debt, was previously extended retroactively back to January 2014, but expired at the end of the year.
Members of both the House and Senate have introduced bills this year to extend tax forgiveness for 2015 and 2016. Reps. Tom Reed, R-N.Y., and Charles Rangel, D-N.Y., have introduced a two-year extension bill (H.R. 1002), which has 85 co-sponsors in the House. In addition, Sens. Debbie Stabenow, D-Mich., and Dean Heller, R-Nev., introduced a similar tax forgiveness extension bill (S. 608), which has 12 co-sponsors.
The Mortgage Forgiveness Debt Relief Act was first passed in 2007 when house prices were plummeting. The National Association of Realtors would like Congress to make the tax relief measure permanent. But at this point, NAR officials are hoping that a two-year extension will be included in a larger bill that extends nearly 50 tax provisions.
"Ultimately, it will end up being part of a tax package of short-term extenders sometime in the fall. We are hoping for a two-year extension for 2015 and 2016 so people can plan ahead," said Jamie Gregory, NAR's deputy chief lobbyist.
While it has bipartisan support, Finerty doubts Congress will pass an extension. "Today, some members of Congress undoubtedly view the housing crisis as being in its final stages, meaning an extension is less of a priority."
The Wisconsin attorney added the extension bill will "likely become a victim to disputes between Republicans and Democrats over broader tax reform" issues.
What's more, passing a tax relief bill in December retroactive to the beginning of 2015 is not conducive to consumers trying to make a short sale decision midyear. The borrower can get hit with a big tax bill if Congress fumbles the extension. Without an extension, any mortgage principal forgiven by the lender is considered income for tax purposes.
The prospect of getting hit with a huge tax bill is one factor behind the decline in short sales, according to Svenja Gudell, senior director of economic research at Zillow.
Underwater borrowers that choose to continue paying their loans rather over a short sale or foreclosure contribute positively to overall default rates. But the decision also affects inventory. "High negative equity markets have low inventory," Gudell said, and it reduces the number of home sales.
On the other hand, buyers in markets like San Francisco, Los Angeles and Denver, which have experienced high price appreciation, also face the problem of low inventories.
"You have a lot of homeowners who could sell their house. But they would have to become buyers and find another home to buy and get another mortgage. But they can't find one or qualify for another mortgage," Gudell added.
While lenders have eased up their credit standards somewhat, it could stand to get a bit looser. "We are roughly two-thirds back to 2002 levels in terms of availability," Gudell said. "It is not as good as in 2002 obviously, but it is much easier to get a mortgage than two years ago."
Meanwhile, renters are having a hard time becoming homebuyers. They have to save for a down payment, feel secure in their job and find a house, which is tough because of the low inventory.
"I feel like there are a lot of roadblocks on the way to homeownership right now that go beyond the mortgage availability issue," Gudell said.