The Numbers Behind the Foreclosure Process

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Wednesday, December 14, 2011

What are the most pressing issues in housing policy today?

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The views expressed herein are those of the author and do not indicate concurrence by other members of the research staff or the principals of the Federal Reserve Bank of Boston or the Board of Governors of the Federal Reserve System.

There are many pressing issues in housing today and there are many policy tools at our disposal, but the two share little ground: there are very few pressing issues in housing where policy can make a difference. The problem of long foreclosure timelines is one of the few. Research shows that the glacial pace of foreclosure resolution does little to benefit homeowners and exacts a substantial cost on communities. Unfortunately, many current policies slow the foreclosure process without preventing any foreclosures.

Do long foreclosure timelines benefit borrowers? In a recent paper, my coauthors and I looked at the data and found several surprising facts. First, the foreclosure process is long, much longer even than most people realize. The “half-life” of a foreclosure—the median number of months to complete a foreclosure—is more than three years in 29 of the 51 states (including Washington D.C.). Second, the foreclosure process takes much longer in states which require judicial supervision of foreclosures, so-called “judicial” states. Such states account for 26 of the 29 states with half-lives greater than three years. According to proponents, giving a borrower more time should allow more good outcomes, such as catching up on payments or renegotiating the loan.

But the evidence disproves this proposition: borrowers in judicial states are no more likely to become current or to pay off their loans than borrowers in non-judicial states. In other words, troubled borrowers are just as likely to lose their homes in the end with judicial supervision, it just takes much longer. Third, mandatory delays in the foreclosure process, which are designed to help troubled borrowers, do not have the desired effect. Massachusetts instituted a right-to-cure law in 2008 which delayed the foreclosure process by an extra 90 days so that borrowers could work with lenders before the start of foreclosure proceedings. We compared borrowers who received this “right to cure” with borrowers who were not subject to the law, either because they defaulted before the law went into effect or because they lived in neighboring states. We found no evidence of improved outcomes.

What is the cost of long foreclosure processes? The unambiguous effect of delaying foreclosure is that it lengthens the period in which a property is controlled by someone with no long-term interest in the property. As prominent urban economist Edward Glaeser writes:

"Delinquent homeowners want to inhabit and to control their homes. Lenders want to get them out and to limit the damage done to the property. During the foreclosure process, home occupants have no reason to invest in their homes. Indeed, spite sometimes pushes them to abuse the property. [This] logic suggests that such periods ensure an abuse of the housing stock, which is one reason why homes often lose close to half of their value when they go through foreclosure."

In recent unpublished work, my colleagues and I looked at the relationship between distressed properties and the sale prices of nearby homes. We found, consistent with earlier research, that houses near foreclosed property sell for lower prices; but we also found that the relationship appears long before the foreclosure—the presence of a property with a seriously delinquent mortgage corresponds to a comparable price reduction. Further, we found that the resale of the property to a new owner begins the healing process. One year after a sale out of foreclosure, the presence of formerly troubled properties is associated with a minimal reduction in the price of nearby properties.

Paul S. Willen is Senior Economist and Policy Advisor for the Federal Reserve Bank of Boston.

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