With the new year underway, many folks—homebuyers especially— are wondering if and when a wave of foreclosures and short sales will hit the market. I won’t go into detail about the differences between a foreclosure and a short sale in today’s blog, but my goal is to simply explain why a glut of foreclosures and short sales won’t be at our doorstep anytime soon. (If you’re interested in learning those differences, though, please reach out; I’d be happy to have that conversation with you).
First of all, let’s explore how foreclosures and short sales even happen—how does someone find themselves “upside down” on their mortgage? As an example, we’ll say you bought a $550,000 home and financed that purchase with a $500,000 mortgage; if the market shifts and brings the value of your house down to $450,000, then you’d owe more on your loan than your home is worth. Given enough time, your home would almost certainly start appreciating again, which would lift you out of the hole (as would your mortgage payments to the principal). But what if, for some reason, you needed to sell shortly after the market shifted, when you owed more on your home than it was worth? Well, your two options would be a short sale or a foreclosure.
Due to the economic havoc wreaked by COVID-19, plenty of Americans found themselves unable to make their monthly mortgage payments. How many will still be unable to pay their mortgage when their forbearance periods expire and other relief measures cease? Will these properties soon be hitting the market?
For the past eight or so years, the value of homes has been going up; in 2020 alone, the market went up 10.8%. Let’s say you bought a home three or four years ago. In that case, you’ve already enjoyed several years of appreciation. Even if you wanted to refinance or pull some cash out of your home, you won’t be able to borrow 100% of its value. The more equity you accrue, the slimmer your chances are of having to foreclose on the house or head into a short sale.
Now let’s say you bought a $500,000 home at 4% just one year ago but were soon after forced to enroll in forbearance due to unforeseen circumstances (aka COVID-19) neutralizing your income. You then remain in forbearance for the entire year, meaning that you’ve contributed nothing toward your home’s mortgage or property taxes. $500,000 at 4% over 12 months is $20,000, but then if you add taxes on that at 1.25% ($6,250), your total obligation now becomes $526,000. Seems scary, right? Well, fear not, because we’re still missing one key variable: 2020’s monster appreciation of 10.8%.
10.8% of $500,000 is $54,000, meaning that in January 2021, your home would be worth $554,000 and you’d owe $526,000 on it. You’d have $27,750 of equity, which is enough for you to sell your home and not lose a penny on it. Even if the most extreme scenario where a brand-new homeowner contributes nothing to their mortgage and taxes for an entire year, they’d still be able to avoid a short sale or foreclosure. In fact, it’d be very difficult to find yourself facing foreclosure in January 2021.
So, are there tons of market-altering short sales and foreclosures on the way? I don’t see any data that supports it. What would have to change for that wave of foreclosures and short sales to come crashing down onto our market? Basically, there would have to be a sudden and cartoonishly large shift in the balance between supply and demand; there are currently 50% fewer homes available for sale than there were last year at this time (so inventory won’t be soaring upward anytime soon), and the demand for homes is still sky-high (and there’s no indication of that changing soon, either).
The rules of economics tell us that high demand and low supply will always work in tandem to push prices upward. The reality is, the market always shifts. Eventually, we will see all those short sales and foreclosures, but interest rates—and consequently, inventory—would have to increase dramatically. If you’re a buyer who’s been hoping that short sales and foreclosures are around the corner, I have bad news: They won’t be happening in 2021 or anytime soon.
Hopefully, you found this video informative. Reach out to me if you have questions about this or any other real estate topic. Also, as always, just give me a call or send an email if you’re thinking about buying or selling soon; I’d love to get the conversation started!