Mortgage market is unprepared for climate risk, says industry report

Record-setting rain, floods and wildfires are examples of the rising risks to the U.S. housing market from climate change.

Mortgage lenders and investors are woefully unprepared not only to mitigate their risk but to even gauge that risk, according to a new report from the Mortgage Bankers Association’s Research Institute for Housing America.

“They are anxious to figure out what to do but not sure where to go to find out. They are unprepared but no longer unaware,” said Sean Becketti, author of the report and former chief economist at Freddie Mac.

There are numerous stakeholders in housing finance, including consumers, landlords, homebuilders, appraisers, mortgage originators and servicers, insurance companies, mortgage investors, government agencies, and the government-sponsored enterprises that issue mortgages (Fannie Mae and Freddie Mac). That means climate change will send significant pressure down a long financial line.

Not only is climate change putting more stress on the National Flood Insurance Program, it could increase mortgage default and prepayment risks, trigger adverse selection in the types of loans that are sold to the GSEs, increase the volatility of house prices, and produce significant climate migration, according to the report. 

For instance, lenders who securitize their loans with the GSEs could face additional costs for representation and warranty insurance, which covers breach of contracts or warranties in large financial transactions, and higher risk as the GSEs revise their requirements in response to climate change.

More specifically, the GSEs might require lenders to perform additional due diligence to determine the need for flood insurance, and the lag in updating official flood maps may force lenders to incorporate additional sources of information on flood risk. As a result, the GSEs might not be allowed to buy loans on homes with higher flood risks.

In addition, the National Flood Insurance Program is in the midst of a major overhaul, which will change pricing for homeowners. That will affect home values and consequently the values of the mortgages that back those homes.

The biggest problem right now is uncertainty for mortgage stakeholders.

“They’re wondering what to do next more than anything else. There haven’t been any rule changes that affect the firms in the mortgage market, but they’re being contemplated,” said Becketti.