Why banks are reluctant to foreclose on expensive homes

By Felix Salmon
February 28, 2012
article today, showing that expensive homes are less likely to be foreclosed on than cheaper homes.

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The WSJ has an interesting if unsurprising article today, showing that expensive homes are less likely to be foreclosed on than cheaper homes.

This stands to reason, of course. For all the talk of strawberry pickers buying McMansions at the height of the subprime bubble, expensive homes are much more likely to be owned by rich people than cheap homes are. And if a rich person owes a bank somewhere north of a million dollars, the bank is likely to be quite aggressive in attempting to get all of the money it’s owed, rather than simply letting the borrower walk away from their house. For a $200,000 house, by contrast, the cost of aggressively pursuing the homeowner is much less likely to be worth the marginal benefit.

On top of that, there’s a reasonably liquid market for smaller homes — if you put them on the market in a fire sale, there’s a good chance that they will sell, quickly, for within $25,000 or so of their fair market price. In the million-dollar-plus range, however, homes stay on the market much longer, the discounts for fire sales are larger, there’s no real rental market, and the cost of maintaining the home while it’s unsold can be substantial.

That said, there is a problem here, and it’s not that people in expensive houses get to live rent-free for 792 days on average. Rather, it’s that people in normal-sized homes are treated unnecessarily badly by Fannie and Freddie.

Smaller mortgages are more likely to be bundled into securities and later resold to investors with backing from Fannie Mae and Freddie Mac. Fannie and Freddie, the government-controlled mortgage giants, have set strict foreclosure timelines and will fine mortgage servicers that are found to be needlessly delaying the foreclosure process.

There’s no reason why mortgage workouts should be long, drawn-out affairs. Indeed, if you’re going to do some kind of restructuring, it’s always better to do it sooner rather than later. But the fact is that the big banks in America are pretty incompetent when it comes to these things: they lose paperwork all the time, they don’t provide a single point of contact for homeowners, their left hand doesn’t know what their right hand is doing, etc etc. But here’s the problem: as all those obstacles and delays get thrown up, the banks get ever closer to the Frannie-imposed deadline, and are effectively forced to foreclose even if they have good workout options. Freddie Mac tells the WSJ that it requires mortgage servicers to “explore every possible avenue to help a struggling borrower avoid foreclosure” — but if at first that servicer messes things up, Freddie’s far from sympathetic about giving them time to try to rectify the error.

It gets worse. The WSJ piece includes the story of Virgilio Wani and his wife, who became delinquent on their mortgage when they both lost their jobs. As soon as Mr Wani got a part-time job, he tried to start making payments again, but the bank refused those payments and foreclosed instead, handing title to Freddie Mac. What did Freddie Mac do with the house once it had title? First, it evicted the Wanis. Then, it started talking to them about a loan modification. Not to put too fine a point on it, this is the wrong way round.

It’s entirely possible that Freddie Mac and the Wanis will find a solution which allows the Wanis to get back the title to their home. So long as that’s a possibility, the Wanis should absolutely remain in their home: evicting them does nobody any good at all.

It’s a perennial frustration to me that foreclosure always and everywhere seems to be followed immediately by eviction. That’s just stupid, for all concerned. Kicking people out of their home creates a lot of deadweight losses which can’t ever be recovered. In a case like this one, where there’s a good chance that the original homeowner will regain title, the best solution is clearly for that family to remain in the home until the situation is resolved one way or the other.

But even when there’s no chance of the former homeowner being able to buy their home back, it still makes sense to keep that family in their home. These days, many if not most of the people buying homes out of foreclosure are buying those homes to rent out, rather than to live in. And it makes perfect sense to rent the home to the family which has been living there for years, if you can. It’s always worth a try.

So for me the important thing isn’t the amount of time between delinquency and foreclosure, but rather the amount of time between delinquency and eviction. Let’s allow families to stay in their homes even after they’ve been foreclosed upon, unless and until the home is sold to someone who doesn’t want to keep that family on as renters. It would improve the quality of life for millions of people, and would create economic value at the same time. What’s not to love?

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Comments
18 comments so far

Well, that’s part of it. The other part is that they would then have to write off the first and second liens. And this is something they really don’t want to have to do, because it might make it more obvious that they are insolvent.

Posted by Foppe | Report as abusive

Foppe, erm how did you work that one out? How would letting someone live in a foreclosed on property force the banks to write off first and second liens?

Posted by Danny_Black | Report as abusive

These days, many if not most of the people buying homes out of foreclosure are buying those homes to rent out, rather than to live in.
__

That is a FALSE assumption. maybe in some areas – think Florida but it is NOT the majority nor the rule.

In this 3 county area, only 1 REO has been sold and then rented.

Single Family Homes as a rental property are a losing proposition. The property insurance costs more. The real estate taxes cost more. The owner not only has to pay the mortgage but they want a profit and the rent to cover repairs/maintenance.

There is no economy of scale in SFR rentals as there is in apartment buildings

If the defaulting debtors couldn’t pay their mortgage (+taxes and insurance) then there is no way they certainly can not pay enough to cover the owner’s new mortgage, the higher taxes and insurance (higher because it is not owner-occupied), the owner’s profit and the owner’s cost of property management and repairs.

The numbers simply do not work.

And why should those who can not their mortgage (rent to the lender as a practical matter) not be forced to move? If they had been renting (and it was rent and not a contract to pay monthly to eventually own it) and didn’t pay, they would be evicted.

And a defaulting debtor who is allowed to remain as a tenant is not going to landscape the yard or maintian the place. And it is cost prohibitive for the owner/landlord to do so on a Single Family Residence.

Posted by onthelake | Report as abusive

Danny_Black, don’t be distracted by the proposal to let foreclosed-on borrowers live in the home as a lessee after the lender takes the home back.

The fact that the home was foreclosed on will itself force the lender to write off the loan or at least mark it to market, rather than holding that loan at book (i.e., the “let’s pretend”) value.

Posted by Strych09 | Report as abusive

Felix: You neglect the biggest problem here: there is a principle-agent conflict between the servicer bank and the noteholder.

It is in the interest of the noteholder to immediately modify and work things out, to cost-effectively turn forclosures into rentals, etc. But it is in the interest of the servicer, who the lender is negotiating with, to drag things out and make sure things fail.

Since the servicer gets paid more when things foreclose: more fees, more nuisance charges, more penalties, that all get paid first when the property eventually sells on the open market, the servicer’s interests are in conflict to both the borrower and the noteholder.

Basically, the whole Borrower to servicer to noteholder model only work when items are paid on time. As soon as there is non-payment, it would be in the interest of both the borrower and the noteholder to eliminate the servicer altogether: the servicer is acting against the interest of both other parties.

That Fannie & Freddie are blind to this I find remarkable. That some vulture firm hasn’t bought up a ton of particularly wretched subprime to sue the servicers I find even more remarkable.

Posted by NicholasWeaver | Report as abusive

OTL,

I take your point that it is generally uneconomical for owners to rent out single-family homes. But I agree with Felix’s position about the utility of renting foreclosed properties. The main difference is that the bank now owns the home, free-and-clear — no mortgage. In that case, whatever the amount of rent, it covers some of the expenses of maintenance — expenses which are necessary whether or not the home is occupied. And simple habitation retains more of the value of the property.

Posted by jbernar | Report as abusive

Don’t really follow the economic logic here plus, per the previous comment, you need to do a bit more research on how foreclosures work as it is not the banks but the servicers. The rest of the post is jibberish, nonconforming loans are a very different animal.

Posted by Tseko | Report as abusive

Danny: see Strych09′s post.

Posted by Foppe | Report as abusive

There’s also the part where rich people may be able to afford to contest the filings (and the recent report of 89% of cases involving fraud doesn’t bode well for banks in such cases). Unless they are treating expensive mortgages better than cheap mortgages they probably have significant incentive not to go to the court.

Posted by BlakeA | Report as abusive

Strych09, so by your argument, and by extension Foppes, banks should be doing everything they possibly can to avoid a foreclosure which would just about be the opposite of what this article is claiming as well as near on the opposite of what you and others have been claiming, ie that innocent “victims” are being hussled out of their homes by banks somehow wanting to “make profits” despite the fact that none of the people claiming this ever manage to explain why foreclosing on someone produces more profits than having the guy just pay his mortgage on time.

Posted by Danny_Black | Report as abusive

NicholasWeaver, except the servicer doesn’t get paid more but nice try.

Posted by Danny_Black | Report as abusive

You are missing a huge point – lawyers. Poor people are less likely to challenge foreclosures, or at least use lawyers to stall. Stalling is a huge benefit to those people. Do you know what a payment is on a million dollar loan (and in many cases, it was a million dollar home with a million dollar loan because down-payment requirements were so weak). Rich people game the system, or at least have more skill gaming the system.

Posted by winstongator | Report as abusive

After reading through the comments I think I’ve put it together: the banks would benefit by not foreclosing, the servicers delay the paperwork to make the process hit the FHA foreclosure deadling (to increase their fees) – the banks aren’t in the business of being landlords so once they’ve taken the partial haircut (rem: they still collect some from mortgage ins. that the mortgagee paid for) they just put it up for sale rather than get into the rental business. I disagree that SF homes are not good rentals – since the price of the home is now lower and also at a lower interest rate than previously a new owner can take a lower rent than previously and still come out ahead – if they are willing to rent out for 3-7 years and then resell at a higher price they will have a very good gain. If they can keep the previous owner – better yet – that family has ties to the community and I think in most cases is going to take care of the home as well as before while not being responsible for the payment of major repairs. It would also be beneficial to the country to help out fellow humans so that their lives are not disrupted and they can rebuild their lives. Of course the best thing to do would be for the banks to not start the foreclosure process and instead do more to work out a solution – like just refinance the loan at today’s rates to the homeowner for a minimun paperwork fee – the bank doesn’t lose except on not making higher interest – and the community benefits by not disrupting people’s lives and the people are then more productive without this stress hanging over their heads. The only homes that should be foreclosed on are when people walk away completely or quit maintaining as long as they are working towards making payments of principle, taxes and insurance. To the Banks – just offer to lower everyone’s rates to todays rates for a cost only paperwork fee and solve the housing foreclosure problem that you the banks allowed to happen in the first place and your employees made huge bonuses on because all those faulty mortgages made your profits look so good!

Posted by soozoom | Report as abusive

Danny: based on your previous comments, I got the feeling you know at least a little bit about how the whole process works, so why are you deliberately being obtuse?
1. Principal/agent issues. Servicers (and lawyers) have different priorities than mortgage investors broadly defined, and make money off different things than those that would maximize investor returns.
2. Second liens are generally owned by banks, first liens tend to have been sold/chopped up for sale to other investors; so banks/bank servicing depts. can be quite happy to foreclose on homes where they don’t personally stand to lose.
3. assorted criminal actions (foreclosing on homes without mortgages, etc.). Yes, I know you’re playing ostrich, and are declaring your unwavering faith in the US media and banks’ kind hearts.

Posted by Foppe | Report as abusive

Foppe:

3) nope just based on the fact that in virtually no case has there been an issue where the home has not had a mortgage that is not in good standing. Ie in virtually every single reported case the person in question was in default for one reason or another. You have absolutely zero evidence that people are bang up to date are being foreclosed on in any vaguely significant numbers. Whenever someone has been asked to show this they have always pointed to something else.

2) This claim makes no sense. Firstly, in this enviroment, in most cases when a servicer forecloses he is simply not making money. The home is typically worth less than the liens on them, they are having to spend relatively large amounts of money taking people to court which is money upfront which if they are lucky they will get some back months if not years later. Secondly, even when they do finally sell the foreclosed place the servicer then has to fight with the owner of the cashflows over fees and they are constrained on what they can claim. Compare this with the case when the person is paying on time every month, money comes in, a slice is taken and money goes out with no human intervention, which is where they actually make their money. Anyone who is claiming in a down market where homes are regularly going for less than the debts on them that servicers are “incentivised” to foreclose when they don’t have to is flat out lying.

Also if banks are holding a second lien then they are even LESS incentivised to foreclose than the first lien holders are they get paid out of what is left from the first lien.

1) Not entirely sure what “Principal/Agent” issues would be here. The incentive of the investor, once a tenant is not paying, is to get the person out ASAP and the place sold. The incentive of the servicer is also to get the person out ASAP and the place sold so he can get the cash back on what he outlayed on the foreclosure, plus the first three months of mortgage payments he covered when the tenant stopped paying on top of the penalties he pays to the investors if he takes too long to foreclose. The incentive of the lawyer doing the foreclosure is to tie it up ASAP as he is on a fixed fee and timeframe with penalties if he misses deadlines. The bank holding the mortgage on its books has only a certain amount of scope to pretend a loan that is not being paid is is being paid. What he may be incentivised to do is lend the guy some money at an exorbitant rate to cover some of the payments.

I have faith in the media to cover a juicy scandal with a sob story angle and that banks will much more likely lose money due to incompetence and crappy systems than some evil plot hatched in the boardroom.

soozoom, please explain how you hit a deadline by delaying?

Posted by Danny_Black | Report as abusive

Foppe and based on every single post you make you seem to totally ignorant on virtually every single topic related to any aspect of finance or economics or history. No wonder you are such a kindred spirit of David Graeber.

Posted by Danny_Black | Report as abusive

On the one hand, foreclosure is a legitimate mean to force homeowners to pay their debts. Any delaying in doing so is just prolonging the state of crisis.
It should be fair and both poor and rich should be treated under the same terms. I understand that real estate agents are just trying what they can in order to survive the crisis. But there should be some fairness enforced by the states. If states don┬┤t do anything, then we should blame them.
I know that many people will disagree with me, because we are convinced, that realtors are responsible for the crisis. But they are not. They are just victims of the same system failure as the homeowners. So we should not judge them so hard.

Posted by J.B. | Report as abusive

“if they are willing to rent out for 3-7 years and then resell at a higher price they will have a very good gain”

This is the principal justification for owning SFH to lease. “Real estate always goes up.”

How did that work out for you this decade?

Posted by TFF | Report as abusive
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