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A foreclosure crisis spurred by climate change is becoming a real threat to the mortgage industry as extreme storms and other natural disasters increasingly occur in places where borrowers might not have flood or fire insurance.
The industry is not prepared for the effects of such extreme weather and rising sea levels, according to Ed Delgado, CEO of national mortgage trade association the Five Star institute and a former executive at Freddie Mac.
"If we look at the basic foundation of what drives the mortgage market, it is the application of credit risk. What's missing is the understanding of weather risk and where those weather events can take place," Delgado said.
The current system is reactive and local and doesn't include plans for the widespread effects of climate change. That could affect several major housing markets at once.
As it stands, after major natural disasters, mortgage servicers follow guidelines from Fannie Mae, Freddie Mac and the FHA, which own or insure most home loans today.
The guidelines usually involve a temporary moratorium on foreclosures, as well as loan forbearance programs, which allow borrowers to miss a few months of payments but then extend the length of the loan.
This helps borrowers who need to rebuild and may be waiting for insurance payments to repair damage. It also helps people who have lost their salaries temporarily due to a disaster. Again, these are momentary solutions to singular events.
The mortgage market is not factoring the overall risk into its loan underwriting and is not quantifying the amount of potential losses should a wide swath of borrowers walk away from damaged or destroyed homes.
"Whether it's fires and mudslides in California, flooding in Texas, or tornadoes in the Oklahoma region," Delgado said. "It's going to be a problem if the banks don't start to pay closer attention to what those weather risks are."
As an example, Hurricane Harvey, which struck in August 2017, flooded close to 100,000 Houston-area homes. In Harvey's federally declared disaster areas, 80 percent of the homes had no flood insurance, because they weren't normally prone to flooding. Serious mortgage delinquencies on damaged homes jumped more than 200 percent, according to CoreLogic.
Houston could have seen a massive foreclosure crisis were it not for strong investor demand in the market. Houston's economy was strong before the storm, and its housing stock was lean. After the storm, investors swarmed the market, offering troubled homeowners an easy way out, largely in cash.
Investor purchases of 10 or more properties jumped nearly 50 percent in the year following Harvey, according to Attom Data Solutions. Some were large-scale buyers, like Cerberus Capital and HomeVestors of America.
Others were smaller home flippers, like JP Patel, who was still buying properties at a crowded auction event in Houston last October. His company, Texas-based Myers, has purchased 80 Harvey-damaged properties.
"As an investor, it was kind of a perfect opportunity," said Patel. "We literally can avoid the whole problematic nature of the foreclosure process."
Houston dodged a crisis because it was already a hot housing market, and people still wanted to live there after the storm. But Houston should be a wake-up call to the rest of the nation, according to Delgado, specifically because the damaged homes were largely not in FEMA flood plains, and were therefore not required to have flood insurance.
"You have this tremendous urbanization, population growth. Roads that are being built in the last 10 years. Where does the water go?" Delgado asked. "And is there an underlying risk for us to examine with respect to our portfolio? And then make decisions. Should we be lending in those markets?"
Lenders today, and the federal government that backs most loans, base their risk on FEMA's flood maps, but even top FEMA officials admit the maps don't account for increasingly extreme weather.
"We can't try to determine what's going to happen in 12 months beyond, because insurance is set up for what your risk is today. And it wouldn't meet actuarial science to charge you for a future potential," said David Maurstad, FEMA's deputy associate administrator for Insurance and Mitigation.
FEMA is required to update its maps every five years. Maurstad says it relies heavily on local communities reporting problems — but some don't because they don't want their insurance premiums to go up.
"We know that only one-third of the properties in the high-risk area have flood insurance, so we have a lot of work to do," he said.
In Houston, flood insurance is now far more expensive because of Harvey. Amanda LeCureux has been running foreclosure auctions for the past two decades, but last October it was the past two years that had her most concerned.
"I have a homeowner, for example, who flooded in 2016 and then promptly flooded again in 2017. And while they did have flood insurance, that flood insurance used to cost them $600 a year. The projected premium for next year is $9,000," said LeCureux.
"And that particular homeowner was stating that, while they can afford to pay the $9,000 for flood insurance alone, they just don't know that they're interested in staying in that home where they've already flooded twice in two years and with the increase in insurance," she added.
And that brings up another problem, said LeCureux.
"Who's going to buy their home? Which homeowner is going to buy the home that's been flooded two times and then will be burdened with a $9,000 flood insurance policy?"
Borrowers may simply decide to walk away from homes that they either can't afford to rebuild or no longer want to live in. As extreme storms and weather events, including drought and wildfires, become more frequent and widespread, the potential for a climate-induced foreclosure crisis increases.
So far, according to Delgado, the mortgage industry has not caught up with the new climate reality and its increasing risk.
"I think it's only been in the last decade that we've started to understand that [Hurricane] Katrina wasn't a fluke, that there will be ongoing, massive events, weather events, taking place, exposing potentially trillions of dollars of real estate to coastal flooding and damages," said Delgado.
"It simply can't be ignored anymore. We've been given enough warning signs to take corrective action, and it's about time you get proactive instead of waiting for these cataclysmic events to take place."
-- CNBC's Erica Posse and Lisa Rizzolo served as producers.