Buyers Returning to Housing Market Ready, Willing, and Able?

There are 9.3 million former homeowners who were displaced by foreclosures, short sales, and deeds in lieu of foreclosure between 2006 and 2014.  Do they constitute a potential market that could drive demand for new and existing homes over the next decade?  The National Association of Realtors® (NAR) has just released a study of that pool and their findings that many of them are already homeowners again and many others will never return to homeownership.

To date, nearly a million of these former owners have returned to the market and many more of these "return buyers" (also referred to as "boomerang buyers") are already qualified, but waiting.  Overlays and credit impairment have held a significant number back and could impact thousands more potential return buyers in the coming years. 

Lawrence Yun, NAR chief economist, says there were two waves of defaults during the housing crisis, the first involving subprime and then prime borrowers. "While loose lending standards in the mid-2000's led to the rise in subprime buyers who ultimately became distressed owners, falling home prices and rising unemployment resulted in a large share of prime borrowers also defaulting or going through a short sale," he said. "Now fueled by a gradually improving economy and the strong rebound in home prices, some of these former distressed owners have returned to the market, and more will likely become eligible in coming years."

NAR analyzed these former owners taking into account multiple factors:

• The time a buyer must wait to be re-eligible for a financing program with timing like the FHA
• The time necessary to repair the distressed seller's credit
• Whether the distressed seller's credit profile, at the time of purchase, was unacceptable by historic, sound underwriting standards
• Whether the return buyer would meet credit overlays in the current stringent environment
• The time needed to build down payment for a purchase
• Whether the buyer has the desire to own again

In an article on NAR's Economic Commentaries Blog, Ken Fears, Director, Regional Economics and Housing Finance reported that the study found the time required for the former homeowners to repair their credit scores, build a down payment and other post-distress factors are limiting the return of many to the market, however since 2006 it appears that about 950,000 have purchased homes. 

Using data from the Hope Now program NAR subdivided borrowers into prime and subprime categories and imputed estimates of owner-occupants.  The resulting homeowners were then separated into year-buckets based on their re-eligibility for FHA financing which requires a three-year waiting period for foreclosures and short sales (with exceptions for extenuating circumstances which the study also attempted to take into account.)

The FHA programs guidelines require less wait time, lower down payments, lower FICO scores, and a shorter waiting period for potential return buyers and thus a better avenue for re-entry to the market.  While some borrowers may use the VA or the extenuating circumstances program at the GSEs NAR uses FHA as shorthand for those other programs.  The choice of program and eligibility for extenuating circumstances shifts the distribution of repurchasers significantly.  A simple estimate that assumes the use of GSE programs for eligibility and/or excludes extenuating circumstances misses many borrowers who would be eligible earlier and including investors over-estimates the number of owner occupants returning.

NAR said that while distressed sales have a significant negative impact on a borrower's credit score (50 to 125 points for a short sale, 85 to 160 points for a foreclosure), distressed sales are often a sign of a larger problem and issues with other lines of credit.  The cumulative impact is a drop of 170 to 200 points which can take years from which to recover.  Further, this pattern tends to persist for years after foreclosure. 

Annual estimates of the share of foreclosed borrowers that recover to pre-event credit score levels were incorporated to adjust the year-buckets by the time for credit recovery.  As depicted above, after 10 years the credit profile of nearly all subprime borrowers had recovered to ex-ante levels, while just roughly 70% of prime borrowers had recovered.  For this analysis, a borrower is assumed ready to purchase once they achieve their pre-crisis credit score.

Research by Federal Reserve economist John Krainer suggests that roughly 40% of prime buyers and 10% of subprime borrowers purchase again within 10 years after foreclosure.  NAR research extrapolated this to assume that 20.5 percent of subprime borrowers are willing to repurchase and 77 percent of prime borrowers.  The lower willingness to buy among subprime borrowers is in line with other research findings that the intentions to own among lower income respondents was less predictive of behavior.   These estimates do not take into account the ability to build a down payment and reserve.

NAR says that beyond the required waiting period not all households with the desire to repurchase could have obtained a mortgage in recent years.  Credit scores for both FHA and GSE mortgages are elevated 40 to 60 points from historic norms and many lenders and aggregators overlay even higher scores.  The risk layering that allowed some borrowers to obtain their old mortgages have been minimized under new regulations, and some borrowers were only able to obtain financing during the boom by using risky and high priced loans.  Combined, these conditions create headwinds to re-entry for subprime borrowers for which the research had to account.

NAR found that, in addition to the roughly 950,000 former owners who have once again become eligible for FHA financing and are assumed to have bought an additional 163,000 are both program and credit qualified but may face lender overlays. Another 187,000 have multiple risk factors that lax lending standards during the peak overlooked.  These borrowers, though program and credit eligible, would likely not qualify in a market with normalized underwriting standards.

Looking ahead NAR estimates that between now and 2023 another 1.63 million former homeowners will become program and credit eligible; 140,000 will face problems because of their credit and half of these will not qualify in a normalized underwriting environment.

The bulk of subprime borrowers are already program eligible for financing and are likely waiting to become credit eligible while the bulk of prime borrowers are not yet program eligible.     Nearly 260,000 will not qualify in the current underwriting environment.

The states likely to benefit the most from returning buyers are essentially the same that suffered most during the foreclosure crisis.  Between 2006 and 2014 California has seen the most returning buyers, followed by Florida, Arizona, Michigan and Georgia.  Over the next nine years NAR projects that Florida will nearly catch up with California while Illinois and Georgia will rise modestly.  The shift in the future trend will reflect a larger share of prime borrowers dragged into distressed events as result of price declines and weak employment rather than risk lending.

NAR says as the bulk of the remaining group of return buyers will enter the market over the next five years but overlays will continue to push off a significant number.  "These return buyers constitute demand that is in addition to nascent household formation and the normal baseline demand from trade-up buyers." It is possible that new scoring models that credit former owners for their performance paying rent, utility, and telecom bills will improve the propensity of these borrowers to return, while reducing their risk to market insurers.

Since FHA will be the financing choice for many of these buyers the agency will need to maintain a broad and diversified pool in order to limit the impact of losses.  Most, however will have restored their prime credit profile.  These buyers have a profile similar to trade-up buyers; further along their lifecycle and likely to prefer single family housing rather than condos or coops.

NAR concludes, "The country and housing market are still healing from the collapse of the foreclosure and distress sale wave.  As home prices rise and the economy improves, these trends will abate, but there remains a large reserve of former owners who have the desire and ability to return to the market.  New credit models and financing opportunities combined with fundamental changes to the mortgage origination process will help to ensure that soundness of the market as these borrowers return."