Climate change is starting to transform the classic home loan, a fixture of the American experience and financial system that dates back generations.
By Christopher Flavelle, The New York Times, June 19, 2020
WASHINGTON — Up and down the coastline, rising seas and climate change are transforming a fixture of American homeownership that dates back generations: the classic 30-year mortgage.
Home buyers are increasingly using mortgages that make it easier for them to stop making their monthly payments and walk away from the loan if the home floods or becomes unsellable or unlivable. More banks are getting buyers in coastal areas to make bigger down payments — often as much as 40 percent of the purchase price, up from the traditional 20 percent — a sign that lenders have awakened to climate dangers and want to put less of their own money at risk.
And in one of the clearest signs that banks are worried about global warming, they are increasingly getting these mortgages off their own books by selling them to government-backed buyers like Fannie Mae, where taxpayers would be on the hook financially if any of the loans fail.
“Conventional mortgages have survived many financial crises, but they may not survive the climate crisis,” said Jesse Keenan, an associate professor at Tulane University. “This trend also reflects a systematic financial risk for banks and the U.S. taxpayers who ultimately foot the bill.”
The trends foreshadow a broader reckoning. The question that matters, according to researchers, isn’t whether the effects of climate change will start to ripple through the housing market. Rather, it’s how fast those effects will occur and what they will look like.
The change has already begun. It’s not only along the nation’s rivers and coasts where climate-induced risk has started to push down home prices. In parts of the West, the growing danger of wildfires is already making it harder for homeowners to get insurance.
But the threat that climate change poses to the 30-year mortgage is different, striking at an American social institution that dates from the Great Depression. Before that, many home loans required owners to pay lenders back just a few years after buying a house, which led to waves of defaults and homelessness, according to Andrew Caplin, a professor of economics at New York University.
In response, the federal government created the Federal Housing Administration, which in turn standardized the way Americans finance their homes.
There was nothing magical about a period of 30 years, Dr. Caplin said; it simply proved useful, making payments predictable and affordable by stretching them out over decades. “It was designed from a viewpoint of a consumer, who wouldn’t find it too hard to understand exactly what they had committed to,” Dr. Caplin said.
But now, as the world warms, that long-term nature of conventional mortgages might not be as desirable as it once was, as rising seas and worsening storms threaten to make some land uninhabitable. A retreat from the 30-year mortgage could also put homeownership out of reach for more Americans.
Changes to the housing market are just one of myriad ways global warming is disrupting American life, including spreading disease and threatening the food supply. It could also be one of the most economically significant. During the 2008 financial crisis, a decline in home values helped cripple the financial system and pushed almost 9 million Americans out of work.
But increased flooding nationwide could have more far-reaching consequences on financial housing markets. In 2016, Freddie Mac’s chief economist at the time, Sean Becketti, warned that losses from flooding both inland and along the coasts are “likely to be greater in total than those experienced in the housing crisis and the Great Recession.”
If climate change makes coastal homes uninsurable, Dr. Becketti wrote, their value could fall to nothing, and unlike the 2008 financial crisis, “homeowners will have no expectation that the values of their homes will ever recover.”
In 30 years from now, if global-warming emissions follow their current trajectory, almost half a million existing homes will be on land that floods at least once a year, according to data from Climate Central, a research organization. Those homes are valued at $241 billion.
Currently, new research shows banks rapidly shifting mortgages with flood risk off their books and over to organizations like Fannie Mae and Freddie Mac, government-sponsored entities whose debts are backed by taxpayers. In a paper this month in the journal Climactic Change, Dr. Keenan and Jacob T. Bradt, a doctoral student at Harvard University, described the activity, which suggests growing awareness among banks that climate change could cause defaults.
Tellingly, the lenders selling off coastal mortgages the fastest are smaller local banks, which are more likely than large national banks to know which neighborhoods face the greatest climate risk. “They have their ears to the ground,” Dr. Keenan said.
In 2009, local banks sold off 43 percent of their mortgages in vulnerable zones, Dr. Keenan and Mr. Bradt found, about the same share as other areas. But by 2017, the share had jumped by one-third, to 57 percent, despite staying flat in less vulnerable neighborhoods.
If coastal mortgages defaulted on those loans, it could cause losses for Fannie and Freddie. That pain could spread to taxpayers: In 2008, the two firms required $187 billion in public aid to stay solvent. They later repaid the money.
In a separate working paper with Marco Tedesco and Carolynne Hultquist of Columbia University’s Lamont-Doherty Earth Observatory, Dr. Keenan found banks protecting themselves in other ways, such as lending less money to home buyers in vulnerable areas, relative to the value of the homes.
Typically, a bank will lend about 80 percent of the cost of a house, with the buyer putting down the other 20 percent. But examining several counties particularly exposed to rising seas, the researchers found that a growing share of mortgages had required down payments between 21 percent and 40 percent — what Dr. Keenan called nonconventional loans.
In coastal Carteret County, N.C., the share of nonconventional mortgages increased by 14 percent between 2006 and 2017 in the areas most exposed to sea-level rise. That change can’t be explained by the general trend there: In the rest of Carteret County, nonconventional loans became less common during the same period.
Similarly in St. Johns County, Fla., south of Jacksonville, between 2006 and 2017, the share of nonconventional loans in the most vulnerable areas increased by 6 percent, while falling 22 percent in the rest of the county. “You’re seeing a statistically significant trend,” Dr. Keenan said.
The Mortgage Bankers Association, a trade group, declined to comment directly on the findings. Pete Mills, the association’s senior vice president of residential policy, cited the requirement for homeowners to buy insurance.
“Lenders make sure all properties are properly insured,” Mr. Mills said in a statement. “For loans in Special Flood Hazard Areas, flood insurance is required,” he added, referring to areas the Federal Emergency Management Agency has determined have a high flood risk.
Fannie Mae and Freddie Mac said, “Any loan located in FEMA-designated Special Flood Hazard Areas must have flood insurance in order for the loan to be purchased by Freddie Mac or Fannie Mae.”
But flood insurance isn’t likely to address the problem, Dr. Keenan said, because it doesn’t protect against the risk of a house losing value and ultimately becoming unsellable.
Lenders aren’t the only ones who seem to be inching away from traditional 30-year mortgages in risky areas. More homeowners are also taking out a type of mortgage that is less financially painful for a borrower to walk away from if a home becomes uninhabitable because of rising seas. These are known as interest-only mortgages — the monthly payment covers only the interest on the loan, and doesn’t reduce the principal owed.
Under normal circumstances, this kind of loan sounds like a bad deal: It’s a loan you can never pay off with the regular monthly payments. However, it also means buyers aren’t sinking any more of their own money into the property beyond a down payment. That’s an advantage if you think the property may become unlivable.
“A household that expects the house will be flooded within a decade, say, is unlikely to value the accumulation of equity in this house,” said Amine Ouazad, an associate professor of real estate economics at HEC Montreal who has researched the practice. “The ability to walk away from a mortgage in case of major floods or sea-level rise is a feature.”
In new research this month, Dr. Ouazad found that, since the housing crash, the share of homes with fixed-rate, 30-year mortgages has declined sharply — to less than 80 percent, as of 2016 — in areas most exposed to storm surges. In the rest of the country, the rate has stayed constant, at about 90 percent of home loans.
Part of the difference was the interest-only loans, Dr. Ouazad found. More than 10 percent of homeowners in those areas had interest-only loans in 2016, compared with just 2.3 percent in other ZIP Codes. The work hasn’t been peer-reviewed, and more research is needed, Dr. Ouazad said. But he said there’s reason to think climate risks are part of the explanation.
The tougher question, according Carolyn Kousky, executive director of the Wharton Risk Center at the University of Pennsylvania, is what happens after that, when people quite simply no longer want to live in homes that keep flooding. “What happens when the water starts lapping at these properties, and they get abandoned?” she said.