The financial picture is changing, as climate change starts to play an outsized role in the mortgage market. According to a new analysis published by First Street, a climate risk assessment firm, that trend is shifting dramatically. Climate-related factors are now an essential consideration in assessing credit score risk. The new factor comes in response to some truly scary numbers. Annual costs associated with climate-related disasters have increased 1,580% in just the last forty years.
The National Oceanic and Atmospheric Administration (NOAA) maintains a comprehensive database. It keeps track of weather and climate related disasters that exceed one billion dollars. Staffing cuts during the Trump administration stopped progress on updating this key resource. This lack of attention creates a disturbing scenario where we do not have the data needed to properly evaluate our exposure to climate risk.
Yet our mortgage markets are becoming more and more subject to climate risk. Consequently, conventional credit scoring algorithms will have a difficult time combating these new dangers. Jeremy Porter, head of climate implications at First Street, emphasized the need for a comprehensive understanding of how climate impacts creditworthiness.
“Mortgage markets are now on the front lines of climate risk.” – Jeremy Porter
The analysis reveals an alarming development. Flooded properties default at much higher rates than nearby, unflooded properties during major events with disastrous flooding. Front and center is the reality—based on historical data—that post-flood foreclosures of damaged homes increases by an average of 40%. This trend showcases the growing and concentrated effects that costly weather disasters are having on the mortgage market. These catastrophes both result in immediate damages and set off secondary effects, such as hikes in insurance prices.
In particular, lender losses are currently concentrated in three states: California, Florida, and Louisiana. Those consumers, particularly those at risk along the coasts of Florida, are already starting to feel the pinch from increasing premiums for their insurance. Recent hurricanes have been more devastating and more frequent, accounting for these huge jumps. This situation makes it impossible for many Americans to afford a premium to live in coastal areas.
Porter’s report makes for a pretty scary forecast. Within a decade, losses on weather-related mortgages could climb to $5.36 billion—nearly 30% of total foreclosure losses. In a typical severe-weather year, these climate-driven foreclosures would lead to losses for banks of $1.21 billion. This would amount to just 6.7% of total foreclosure credit losses.
“There is a significant amount of credit loss risk related to climate that is currently hidden from traditional credit loss models. This reports the systemic effect weather disasters are having in the mortgage market from both direct damages, but also indirect impacts like increasing insurance costs.” – Jeremy Porter
These findings are especially worrisome considering what these findings could mean for the future of home financing in climate-risky areas. Lenders and consumers alike will have to carefully traverse this changing tide. They should know how climate change will affect mortgage lending and housing property values and insurance premiums. Mortgage markets are evolving to the realities of a new landscape. A few examples as to how stakeholders can create new approaches that better integrate climate risk into lenders’ underwriting.