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May 06, 2008

Mortgage Delinquencies and Foreclosures

Ben Bernanke
Chairman, Board of Governors of the Federal Reserve System
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The following excerpt is drawn from Ben Bernanke’s remarks at last night’s Annual Dinner, at which he was honored with the Distinguished Leadership in Government Award. download the full text

Many foreclosures are not preventable. Investors, for example, are unlikely to want to hold onto a property whose value has depreciated significantly, and some borrowers — perhaps because they were put into an inappropriate loan or because personal circumstances have changed — cannot realistically sustain homeownership. However, if a foreclosure is preventable, and the borrower wants to stay in the home, the economic case for trying to avoid foreclosure is strong.

Clusters of foreclosures can destabilize communities, reduce the property values of nearby homes, and lower municipal tax revenues. At both the local and national levels, foreclosures add to the stock of homes for sale, increasing downward pressure on home prices in general. In the current environment, more-rapid declines in house prices may have an adverse impact on the broader economy and, through their effects on the valuation of mortgage-related assets, on the stability of the financial system. Thus, finding ways to avoid preventable foreclosures is a legitimate and important concern of public policy.

To determine the appropriate public- and private-sector responses to the rise in mortgage delinquencies and foreclosures, we need to better understand the sources of this phenomenon. In good times and bad, a mortgage default can be triggered by a life event, such as the loss of a job, serious illness or injury, or divorce. However, another factor is now playing an increasing role in many markets: declines in home values, which reduce homeowners’ equity and may consequently affect their ability or incentive to make the financial sacrifices necessary to stay in their homes.

On the principle that a picture is worth a thousand words, Federal Reserve staff, using detailed, county-by-county information on mortgage performance, have developed a series of heat maps, which summarize the incidence of serious mortgage delinquencies across the nation as well as some of the key drivers of loan performance. As the examples will make clear, the figures use warmer colors — orange and red — to show counties for which the factor being considered has a higher value or change. Lower values or changes are indicated by cooler colors — shades of green and yellows — indicate areas where the factor under consideration has a moderate value or change.

 

download all seven heat maps

What are the implications of these relationships, particularly the linkage of mortgage payment problems and falling house prices? Loan servicers are used to dealing with mortgage delinquencies related to life events such as unemployment or illness, with the most common approaches being a temporary repayment plan or the folding of missed payments into the principal balance. A widespread decline in home prices, by contrast, is a relatively novel phenomenon, and lenders and servicers will have to develop new and flexible strategies to deal with this issue. In some cases, when the source of the problem is a decline of the value of the home well below the mortgage’s principal balance, the best solution may be a write-down of principal or other permanent modification of the loan by the servicer, perhaps combined with a refinancing by the Federal Housing Administration or another lender.

To be effective, such programs must be tightly targeted to borrowers at the highest risk of foreclosure, as measured, for example, by debt-to-income ratio or by the extent to which the mortgage is underwater. Finding the right balance — particularly the need to avoid programs that give borrowers who can make their payments an incentive to default — is difficult. But realistic public- and private-sector policies must take into account the fact that traditional foreclosure avoidance strategies may not always work well in the current environment.

Most Americans are paying their mortgages on time and are not at risk of foreclosure. But high rates of delinquency and foreclosure can have substantial spillover effects on the housing market, the financial markets, and the broader economy. Therefore, doing what we can to avoid preventable foreclosures is not just in the interest of lenders and borrowers. It’s in everybody’s interest.

Comments

by Norman | February 08, 2010 at 9:54 AM

These sentiments are still true today. Avoiding foreclosure is in the best interests of the homeowner, the lender and the entire economy. The foreclosure mark on the credit report can be very damaging for a homeowner. Many experts are predicting a new wave of foreclosures in the upcoming years from Option ARM and Alt A loan products readjusting. Homeowners should do whatever they can to avoid foreclosure whether it be loan modification or short sale.

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