Foreclosure-Response.org | Getting Started

What are the root causes of this foreclosure crisis?

Although foreclosures are not a new phenomenon, the scope and scale of foreclosure filings in recent years far surpass anything seen before. Historically, the foreclosure rate has been around 1 percent, but during the crisis that number has risen substantially – often hovering as high as 4 percent or even more (Elmer and Seelig 1998; LPS Mortgage Monitor). The Center for Responsible Lending reports that since 2007, 6.6 million foreclosures have been initiated and up to 12 million more foreclosures are projected through 2015. A study by the Mortgage Bankers Association indicates that 1 in 9 homeowners is delinquent on their mortgage (Snapshot of a Foreclosure Crisis 2010)

On top of "traditional" causes of foreclosure (job loss,

medical emergencies, and other financial setbacks), several factors have

converged to drive the current crisis.

Falling home prices – After many years of strong annual growth, home prices finally began to drop in most markets in 2006 or 2007. To afford the unprecedented housing prices during the boom years, many families took out mortgages there were unaffordable, thinking they could always refinance if they ran into trouble. Once home prices declined, however, many borrowers found themselves "underwater" and unable to sell or refinance their way out of unaffordable loans.

Photo courtesy of McCormack Baron Salazar

Lack of strong economic incentives to provide affordable loans – In many cases, the lenders and brokers who issued mortgages passed them on to wholesalers, who packaged those mortgages into securities that were sold to investors. With little or no stake in the longer term viability of those loans, and the opportunity to earn a commission on each transaction, the lenders and brokers who made the loans lacked a strong financial incentive to ensure that borrowers could actually afford their mortgages.

Poor or fraudulent underwriting – Poor underwriting and the risky loans that resulted do not appear to be driven by Community Reinvestment Act (CRA) requirements that financial institutions make loans in communities where they receive deposits. An analysis on loan performance by the Local Initiatives Support Corporation (LISC) suggests that, although a disproportionate share of subprime loans were made to families in high-poverty areas, two-thirds of subprime loans were made in areas where the poverty level was too low to be eligible for CRA credit. In addition, loans made in high-poverty areas that were eligible for CRA credit performed similarly to the same type of loans made in low-poverty areas. Click here to read more from the LISC report.

Other studies indicate that subprime borrowers often should have qualified for prime loans. The Wall Street Journal reports that 61 percent of subprime loans originated in 2006 went to borrowers that had credit scores high enough to qualify for conventional loans (2009 Center for Responsible Lending). Analysis of foreclosure by race and ethnicity suggests that predatory lending practices were targeted to minorities that may have qualified for less risky loans. Borrowers of color were more likely to receive subprime loans than white borrowers, but within the subprime market, borrowers of color were more likely to receive the most expensive loans associated with increased default risk (2010 Center for Responsible Lending).

Fraud – Lenders were not the only ones guilty of fraud. Some homebuyers falsified their own income on mortgage applications, and some buyers claimed investment properties as their primary residence.

Bad decisions by purchasers and investors – While some borrowers affected by the foreclosure crisis were subject to predatory lending or high-pressure sales tactics, others simply made bad decisions. In some cases, homeowners knowingly took on mortgages that exceeded what they could afford or extracted large amounts of home equity, leaving them vulnerable as home prices began to fall. In other cases, investors took on more risk than they could handle, buying up multiple homes with the expectation that they would be easily able to re-sell these properties at a profit.

Recession and rising unemployment rates - While it is unclear which factors contributed most to the sharp rise in foreclosures, the combination of unsustainable mortgage products, falling home prices, and a lengthy recession have kept the foreclosure rate at historic highs for several years without yet showing signs of recovery.

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What are the impacts of foreclosures on communities?

While foreclosures clearly have a devastating effect on the families directly impacted, they also affect the surrounding community, particularly in areas where high rates of foreclosures have occurred. When foreclosed homes remain vacant and are left poorly maintained, they may become targets for vandalism and crime, exposing neighborhood residents to greater risk and causing the value of nearby properties to decline. In places where property values are already falling, even a small number of foreclosures can accelerate the trend. When home values fall, so does property tax revenue – a major source of income for many municipalities. At the same time, cities may be faced with the growing costs of processing foreclosures and securing and maintaining vacant properties, leaving less revenue available for providing other essential services.

Visit the Policy Guide section on Why Foreclosures Matter to learn more.

From the Forum...

Visit the Forum to view online Q&A with the Urban Institute's Tom Kingsley and Robin Smith, authors of a report about the impacts of foreclosures on families and communities.

The HousingPolicy.org Forum is a place to pose questions, exchange ideas, and learn from the experience and expertise of others. This section of the site features interactive forums organized around policy areas, including foreclosure prevention and neighborhood stabilization.

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Why should state and local governments care?

Foreclosures and mortgage delinquency rates are elevated across most of the country, as the data on metropolitan serious mortgage delinquencies indicates. High volumes of foreclosures don't just affect the families who lose their home, they can have broader "spillover effects" that impact the entire community. When foreclosed homes remain vacant and are not properly secured and maintained, they may become neighborhood eyesores and targets for vandalism and crime. As nearby property values fall in response, property tax revenue falls as well, creating shortfalls in many city budgets. At the same time that revenue is decreasing, demands for city services to provide certain services (such as code enforcement, trash removal, and community policing) may be growing. When foreclosures reach critical levels, municipalities may lack the revenue to provide basic services to all residents.

Visit the Policy Guide section on Why Foreclosures Matter to learn more.

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Why can't troubled borrowers just refinance?

When housing prices were steadily rising in the first part of the 2000s, borrowers faced with unsustainable mortgage payments could refinance before falling behind and either secure a new loan with better terms or extract equity from the home if payments were temporarily unaffordable. Today's troubled borrowers, however, will have a significantly harder time refinancing their mortgages, as a result of several related factors:

Home price declines – After years of increasing, home prices finally began to fall in the 2006 to 2007 period, leaving many borrowers "underwater" – i.e., owing more than their homes were worth – and unable to refinance their mortgages. In 2009, the Wall Street Journal reported that nearly 1 in 4 homeowners currently owe more than the property value (Snapshot of a Foreclosure Crisis).

Tightening credit – As the mortgage foreclosure crisis started to unfold, banks and other lending institutions began imposing tighter credit standards on borrowers. People who would have had no trouble getting a loan several years ago may find themselves getting denied on refinance applications, even if their credit score and income haven’t changed.

Declining credit scores – In some cases, homeowners short on cash cannot cover all of their expenses and have to choose each month between paying the mortgage, utility bills, and/or credit card bills. Falling behind on these payments negatively affects borrowers' credit scores, making it even more difficult for them to secure a loan on favorable terms.

The inability to refinance may be particularly devastating for homeowners who took out adjustable rate mortgages or loans with balloon payments under the assumption that they would be able to refinance later.

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Why should we worry about renters in foreclosed homes?

According to the Mortgage Bankers Association, almost 20 percent of all foreclosures involve likely rental properties (one- to four-unit properties that are not owner-occupied) (Brinkmann 2008). A 2009 report from the National Low Income Housing Coalition indicates that around 40 percent of families impacted by foreclosures are renters and rental properties could be involved in approximately half of foreclosures in Nevada, Illinois, and New York (Pelletiere 2009).

Foreclosures on rental properties can cause destabilizing effects on neighborhoods similar to foreclosures of owner-occupied homes. Foreclosed rental properties may remain vacant and fall into disrepair if the new property owners are unable or unwilling to maintain the properties or continue to rent them out. Vacant rental properties can reduce property values of neighboring homes, diminish municipal tax revenues, and contribute to blight and further neighborhood decline.

Even if renters pay their rent on a timely and regular basis, they may have still been at risk of eviction if the house or apartment they are occupying enters foreclosure. In addition to the possibility of eviction, if a lease is terminated due to foreclosure, renters may have difficulty recovering their security deposits. Renters who are evicted may be left with an eviction on their rental record, damaging their credit rating and making it more difficult to get approved for loans or alternate housing in the future.

The Protecting Tenants at Foreclosure Act (PTFA), passed in May 2009, provides significant protections that help to stabilize conditions for renters in foreclosed properties, but these protections currently expire in December 2014. PTFA requires that renters in good standing receive at least 90 days notice before asked to vacate a foreclosed property, and tenants with a written lease can stay through the remainder of the lease with no change in terms. (Where state laws offer greater protections than those specified in the Act, the state law prevails.)

Prior to passage of PTFA, the options available to renters for retaining or restoring stable housing varied widely depending on local and state laws governing renters' rights and/or the foreclosure process, and this will be the case again unless the Act becomes permanent. In some states, for example, a renter could legally receive just three days notice before being ordered to vacate the property, while other states give renters more ample notice, providing more time for a family to secure new housing.

Click here to learn more about protecting renters living in foreclosed homes.

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Why won't lenders modify more loans to prevent foreclosures?

According the Mortgage Bankers Association, the number of borrowers facing foreclosure continues to outpace loan modifications at a rate of twelve to one (2011 Center for Responsible Lending) even though there are a number of steps that lenders or servicers can take to modify mortgages to help families keep their homes. Among other options, servicers could agree to: temporary suspensions of payments to meet a short-term crisis, reductions in the interest rate of the loan, extensions of the length of the mortgage (e.g., from 30 to 40 years), or the write-off of part of the principal balance of the mortgage. During the early part of the crisis, many loan modifications consisted of modest changes that servicers hoped would be sufficient to help families become stable. Unfortunately, when these modest changes have not been enough, families have defaulted again.

Many observers believe that more aggressive loan modifications – including the write-off of principal – are needed to help families avoid foreclosure. Since foreclosed homes are often sold at a steep discount and can leave lenders or servicers with hefty bills for legal expenses, property maintenance, and sales costs, principal write-downs may help maximize the long-term return to investors. A study comparing foreclosures and mortgage modifications suggests that modifications return more value to investors than allowing the properties to go to foreclosure, even with a high re-default rate (2011 Center for Responsible Lending). However, there are a number of impediments to substantial loan modifications.

The issue of legal authority is perhaps the biggest factor; loan servicers' right to proceed to foreclosure is clear, yet their authority to agree to principal write-downs in the face of opposition by the investors who own the loans is not. Some lenders are concerned about the threat of litigation from disgruntled investors in mortgage-backed securities, and investors in the riskiest loans have little incentive to agree to principal write-downs as long as they have hope of some recovery. If investors are convinced by research on the higher return provided by loan modifications, worries about legal challenges may diminish.

Another issue that may impact loan modifications is the financial disincentive for servicers who are not compensated for the extra work involved in processing them. In still other cases, servicers may have determined that even an aggressive loan modification may not be sufficient to provide stability to a family whose income is too low or whose property’s value has declined to such a degree that it cannot sustain the modified mortgage. More aggressive loan modifications have also been hindered by fears that homeowners who are able to pay their mortgage will decide to strategically default in order to reduce their payments.

Photo courtesy of McCormack Baron Salazar

Federal initiatives to increase loan modifications have had limited success to date, in part due to the voluntary nature of the programs and in part due to the severity of the mortgage problems faced by some borrowers.

Following a number of other attempts at federal incentives, the Making Home Affordable program was launched in 2009 to increase borrowers' loan modification and refinance options. Programs available under Making Home Affordable include the Home Affordable Modification Program (HAMP) which offers incentives to servicers to make borrowers' mortgage payments affordable through interest rate reductions and other loan modifications. In addition,

borrowers whose loans are owned or guaranteed by Fannie Mae or Freddie Mac may refinance into a fixed-rate mortgage through the Home Affordable Refinance Program (HARP). Other Making Home Affordable programs offer options for homeowners with income loss, drops in home value, second mortgage problems, and other scenarios that put families at risk of foreclosure. HAMP has averaged 30,000 permanent loan modifications per month (Treasury 2011), but the process of obtaining a permanent modification has been troublesome for some households. Overall the program has not led to as many permanent loan modifications as initially hoped.

States and localities have boosted opportunities for loan modifications by bringing borrowers and servicers together through foreclosure mediation programs and borrower outreach events.

Click here to learn more about foreclosure prevention.

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