The Coming Storm in Mortgage-Backed Securities: Why House-Poor Borrowers Spell Trouble

The U.S. housing market is teetering on a knife's edge, and the cracks are widening. With nearly 22 million homeowners classified as “house-poor” — spending over 30% of their income on housing costs — and mortgage delinquency rates ticking upward, the risks to mortgage-backed securities (MBS) are mounting. For investors in real estate debt, this is no longer a distant threat: it's a present-day crisis in the making.

The Rise of House-Poor Borrowers: A Recipe for Default

Let's start with the raw data. 21.93% of U.S. homeowners are now house-poor, with 44% of these households spending over 50% of their income on housing costs. In states like California (29.92% house-poor) and Hawaii (28.70%), the numbers are catastrophic. Even in regions like the Midwest, where affordability is better, nearly 14% of homeowners are still stretched to their financial limits.

This isn't just a regional issue — it's a systemic one. Wages have stagnated while home prices and mortgage rates have surged. The median existing-home price hit $402,500 in early 2025, and 30-year fixed mortgage rates remain above 6.9%, pricing millions out of the market. For those who bought during the peak, the math is brutal. A $400,000 mortgage at 7% requires a $2,125 monthly payment, eating up 24% of a median income of $90,000 — before taxes, insurance, and utilities.

Delinquency Rates: The Canary in the Coal Mine

The delinquency data paints a grim picture. In Q1 2025, the seasonally adjusted delinquency rate for residential mortgages rose to 4.04%, up from 3.98% in Q4 2024 and 3.94% a year prior. While still below the 2008 crisis levels, the acceleration is alarming.

The worst performer? VA-backed loans, which saw their foreclosure rate spike to 0.84% — the highest since 2019 — as a moratorium on foreclosures expired at the end of 2024. Meanwhile, FHA loans, which disproportionately serve lower-income borrowers, reported a year-over-year jump of 80 basis points in seriously delinquent loans (90+ days past due).

These figures aren't abstract. For MBS investors, they translate to higher default risks, reduced cash flows, and falling security values. The worst-hit MBS pools — those tied to high-cost regions or subprime borrowers — could see steep markdowns.

Regional Disparities: The West Is on Fire, the Midwest Is a Safe Haven

Geography matters. The West Coast, with its sky-high housing costs, is the epicenter of the crisis. In California, a two-bedroom apartment now costs $20.30/hour to afford — nearly impossible for the median renter earning $40,000/year. Meanwhile, the Midwest's affordability index (134.2) reflects a far more stable environment.

Investors in MBS tied to Western markets are particularly vulnerable. Consider the performance of real estate companies in these regions:

Both Z and RDFN have underperformed the broader market by double digits, signaling investor skepticism about the West's housing fundamentals.

The MBS Meltdown: Why Investors Should Worry Now

MBS are only as safe as the mortgages backing them. As defaults rise, the value of these securities plummets. The iShares MBS ETF (MBB), a key proxy for the sector, has already seen outflows as investors retreat.

The risks are twofold:
1. Cash Flow Collapse: Delinquencies reduce principal and interest payments flowing into MBS pools.
2. Collateral Devaluation: Falling home prices (a likely outcome in overheated markets) shrink the equity cushion for lenders.

MBB's underperformance versus Treasuries highlights the growing perception of risk in the sector.

Investment Implications: Act Now Before It's Too Late

The writing is on the wall for MBS investors:
- Avoid Western Exposure: Steer clear of MBS backed by loans in high-cost states like CA, NY, and HI.
- Short MBS ETFs: Consider shorting MBB or VMBS as delinquency rates rise.
- Focus on Safe Havens: Look for MBS pools tied to the Midwest or FHA loans with federal guarantees (though even these have risks).
- Diversify into Alternatives: Commercial real estate (industrial, healthcare) or inflation-linked bonds may offer better returns with less MBS exposure.

The strategy of shorting MBS ETFs during rising delinquency rates has historical support. A backtest from 2020 to 2025 showed that shorting these ETFs during such periods yielded an average return of 12.5%, outperforming benchmarks with a 9.09% compound annual growth rate (CAGR) and a Sharpe ratio of 0.61, indicating strong risk-adjusted returns.

Conclusion: The Clock Is Ticking

The era of easy money in real estate is over. With house-poor borrowers buckling under unsustainable costs and delinquency rates climbing, the risks to MBS are undeniable. Investors who ignore these warning signs are gambling with their capital. The time to reassess portfolios, reduce exposure, and pivot to safer assets is now — before the storm hits full force.

The data is clear: the next crisis isn't coming. It's already here.

This article is for informational purposes only and should not be construed as financial advice. Always consult a licensed professional before making investment decisions.