The U.S. housing market is facing increasing risks from more frequent and damaging natural disasters. While insurers bear the initial brunt of the losses, the mortgage industry could be in an even more precarious position. Unlike insurers who can adjust premiums and underwriting on a yearly basis, mortgage lenders could be stuck with a property for up to 30 years, often on fixed interest rates. This becomes a problem when insurance payouts don’t cover the total costs of rebuilding and homeowners struggle to make mortgage payments.
One major issue is that such risks aren’t currently incorporated into mortgage pricing. The industry has yet to fully account for the potential loss of properties due to natural disasters. This is a concern, especially as climate-related events become more severe and more properties are at risk. Eddie Seiler, Executive Director of the Research Institute for Housing America at Mortgage Bankers Association, explains that it is crucial to explicitly account for these risks in the underwriting process.
A major challenge faced by the mortgage industry is the lack of certainty about climate change and its long-term impact on specific areas. Climate-risk models often provide conflicting projections, making it difficult for lenders to accurately assess the risks associated with individual properties. Timothy Judge, Head of Modeling and Chief Climate Officer at Fannie Mae, emphasizes the importance of using external providers to obtain accurate property-level analytics.
Furthermore, areas with higher climate risks often coincide with areas that are home to black, Hispanic, and lower-income households. If lenders were to start pricing loans based on climate risk, these communities would be disproportionately affected. This poses an ethical dilemma as it could deepen existing inequalities in access to homeownership.
Instead of immediately raising rates or cutting off lending in high-risk areas, lenders can take steps to mitigate climate risk. Education on making properties more resilient and implementing good credit risk management are potential solutions. However, a significant portion of the risk will ultimately be borne by government-sponsored enterprises like Fannie Mae and Freddie Mac, which insure the majority of outstanding mortgage debt in the U.S. without charging location-based premiums.
Passing on climate liabilities to taxpayers without charging extra for mortgage insurance from lenders could lead to further inequities. Vulnerable communities could be left to bear the burden of climate-related costs, while lenders and investors are protected. It is essential to ensure that changes in pricing and risk allocation consider the impact on these communities.
Investors in mortgages protected by federal insurers may also face prepayment risk if properties are destroyed and homeowners walk away. This would result in early buyouts of mortgages, cutting short the expected interest payments for lenders.
Despite the increasing risks, the housing market has yet to fully price in the impact of climate change. Many Americans continue to move to areas vulnerable to hurricanes, wildfires, and extreme heat due to affordable housing and booming local economies. This raises concerns about the overvaluation of homes exposed to flood risks and the potential loss of home equity, particularly for low-income households.
The housing market’s reliance on new developments in vulnerable areas, driven by local governments competing for more development and tax revenue, exacerbates the risks. While it may provide a short-term boost to the housing market, the long-term consequences could be significant. It is crucial for stakeholders in the mortgage industry to proactively address climate risks and incorporate them into their decision-making processes before it is too late.
In conclusion, the U.S. housing market faces mounting risks from natural disasters, and the mortgage industry is particularly vulnerable. It is essential for lenders, insurers, and government entities to collaborate and address these risks proactively to safeguard homeowners and mitigate the potential impact on vulnerable communities. Failure to do so could have severe consequences for the stability of the housing market and exacerbate existing inequalities in access to homeownership.