Many Borrowers Not Interested in Continuing With Mortgage

February 25th, 2009

For Obama solving the foreclosure crisis is a tricky business with many borrowers no longer interested in continuing with mortgages that have gone underwater. It means that the loan amount has become more than the worth of the house. This makes it meaningless for the borrower to struggle to save the property. This problem of negative equity will have to be taken into account while chalking strategies for preventing further foreclosures.

There are instances of many borrowers who despite this negative equity will continue with the mortgage because they do not want the stain of foreclosure on their credit scores. But the majority will tend to walk away because in many states the lenders cannot pursue legally the borrowers for the shortfall.

The advisors of Obama are focusing on the first type relying largely on a study of Boston made by the Federal Reserve. From 1988 to 1993 housing prices fell by 23% in Massachusetts. But despite this 6.4% of the borrowers succumbed to foreclosure. It seemed that despite figures most of borrowers felt that the fight for keeping the houses was not worth the trouble.

The Obama team was also influenced by the results of the action taken by FDIC after acquiring IndyMac when the latter failed. Within few months 10% of 56,000 defaulting borrowers of the bank managed to bring down their payments to 38% less than their earnings.

There are other issues at stake – success being related to the reduction of the principal. An independent financial consultant, Edward Pinto, calculated that 20% of those with negative equity were foreclosed upon during the previous three years partly because they had started with much reduced creditworthiness than their counterparts two decades ago in Massachusetts.

If the crux of the problem is negative equity then there in no alternative to the reduction of the principal. But lenders are not willing by arguing that many borrowers who can afford would now start to intentionally default. There is also the fear that investors would sue servicers for taking the decision about reducing the principal. The total negative equity on residential houses is more than $500 billion. The government could shoulder some of these but it would be at a high price both in terms of dollars and politics.

The reality is that lower principals with matching lower payments are the only solution out of this foreclosure impasse.