Bay Area Mortgage Defaults Holding Steady at High Levels

Bay Area mortgage default rates have fallen from the peak levels recorded in 2009, but seem to have stabilized at relatively high levels.

During the third quarter of 2010, there were 483 default notices recorded in San Francisco, and 12,690 recorded in the nine-county Bay Area. Those figures are more than six times higher than the corresponding figures from the third quarter of 2005.

The recent stability in default activity is at least partially due to forbearance on the part of lenders, who have been under political pressure to help homeowners avoid foreclosure. (Remember, we're not talking about actual defaults, but rather about notices of default, which must be recorded by lenders.) A substantial part of the stability, however, is probably due to the stabilization of Bay Area home prices.

I've talked about the relationship between price declines and default rates in earlier postings, for instance, this one. (The key point is that being underwater on your mortgage makes it tempting to surrender your home to foreclosure.) Now that prices seem to have stabilized, the number of underwater homeowners should begin to fall, mainly due to foreclosures and short sales. That should shortly translate into lower default rates.

Homeowners Are Still Badly Stretched

I said in my last post that homeowners are financially stretched. Indeed, even after three years of economy-wide debt reduction – unprecedented in modern history – households are still carrying financial burdens that would have seemed astronomical before the housing boom. Take a look at the chart, below, which shows the ratio of aggregate household debt to aggregate household income.

Until 1999, household debt had never exceeded 80% of household income. When the housing boom began, however, mortgage debt expanded dramatically, driving the debt-to-income ratio as high as 116% in 2007. The ratio has fallen since then (mainly because of mortgage defaults), but is still more than 30 percentage points higher than at any time before the boom.

Another way to look at debt burdens is to compare debt servicing costs to household incomes. (The chart above uses the total amount of debt rather than the cost of servicing that debt.) Mortgage rates are at 50-year lows, so it’s possible that homeowners can carry substantially higher levels of debt without greater difficulty.

Take a look at the chart, below, which shows the ‘Financial Obligations Ratio’ for homeowners.

The Financial Obligations Ratio is the ratio of aggregate housing costs (including property tax and insurance) to aggregate disposable income. Although not as far out of line compared to historical levels as the debt-to-income ratio, the financial obligations ratio is still higher than at any time before the housing boom, including the peak of 1980’s housing cycle.

Mortgage rates are likely to remain low until a sustainable economic recovery is underway. They're bound to rise eventually, however, driving the financial obligations ratio higher and increasing the pressure on home prices just as the economy begins to recover. All things considered, I’d say that the housing market is likely to remain in the doldrums for years to come.

Note: The ratios shown in the charts are based on aggregate figures, and are only indirectly representative of the debt burdens of typical households. The debt-to-income ratio for a typical first-time homeowner would have been far higher than 116% at any point during the thirty year period shown in the charts.