This week’s post was promised to be about purchasing bank controlled properties, either pre-foreclosure or post-foreclosure homes.  This morning I was asked to comment on this article at MSNBC- http://www.msnbc.msn.com/id/32181495/ns/business-washington_post/ and give “My Take” on it. The short version of what the article claims is that in most cases it can be “More Profitable” for a lender to foreclose on a home than to work out a loan modification or other solution with the borrower. The contention is that the cost of foreclosure and the fact that the majority of borrowers are likely to end up back in default negates any benefit or gains the bank might realize from the modified loans. The commentary become a posting of it’s own, and so I present it to you, the reader, in lieu of the planned post. Buying Pre-Foreclosure and REO properties will appear as next week’s post.

 While it is true that the vast majority of homeowners in trouble are likely to be in trouble again, what it comes down to is a circular problem. Borrowers in trouble stop spending money- They save what they can, and many can indeed “Self-Cure” as the article claims (bring the past due balances current, even if it means a great deal of sacrifice on their part). However, because they are not spending any money, service providers, manufacturers, and other businesses are forced to reduce their staff, and these same borrowers lose their jobs… Putting them right back to a default situation.

 It’s questionable as to whether or not it’s “More Profitable” for the lender to allow the loan to foreclose- It might be more accurate to say it’s “Less Unprofitable”- Lost money is lost money, no matter where you lost it at. In the case of the homeowner who is likely to be back in default in 6 months, a year, two years, it defers the date of the “Loss”, pushing it back however long the borrower can continue to make payments. It’s also true that the foreclosure process itself costs money- Money that, if the lender stops mid-processing or fails to meet certain mandated timelines, they will have to spend again when they start over from the beginning- And can end up an unnecessary expense.

 Homes that the lenders do foreclose on create their own circular problem. The foreclosed owner couldn’t sell the home for what they owed on it because the foreclosed, bank owned (REO or Real Estate Owned) properties already on the market have driven the price of homes down. The homeowner doesn’t sell and the lender forecloses, the house becomes an REO and goes on the market for a “Cut Our Losses” price- Bringing down property values and preventing distressed homeowners from selling their homes for what is owed on them, forcing them to be foreclosed on… Due to the sheer volumes of REO properties the lender would be forced to compete with once the home is foreclosed (and mark my words, the height of the REO inventory levels are still to come), it’s still going to be better for them to modify a loan than it is to foreclose. With each modified loan there is one less REO on the market RIGHT NOW (it may be later, but it isn’t NOW), keeping the prices a little higher for the inventory they already have on the market and for those homeowners who are trying to do the responsible thing and sell it before the lender is forced to foreclose.

 Ultimately, most modified loans do end up back in default in a few months to a few years. But there is no uniform time for that, each borrower is going to be different as to how long they can maintain those new payments. The deferral of the foreclosures on these loans will “Stretch out” the duration of the “Foreclosure Crisis”, making it last longer, however it will spread the volume over time. If all the homes in default were to be foreclosed all at once, prices would plummet to lows your grandparents wish they could have bought their first house for. They wouldn’t bounce right back up, either- It would take time to regrow to the point where existing home owners had any equity in their homes. By distributing the loss over time, values will retreat, reach equilibrium, and begin to accrue value again- Older mortgage loans will re-gain equity through renewed appreciation. In the meantime, newer mortgage loans will take longer to gain any equity, in this case through their regular loan payments that “Buy Down” the balance owed, and achieving equity through a reduced debt. The lower prices are allowed to drop, the longer this will take in either case.

 Ultimately, the article is both correct in the facts stated- It can be “Less Unprofitable” for the lender to pursue the foreclosure instead of the modification, and inaccurate in that it only reports the face of the foreclosure- Without covering the long term economic implications of a massive wave of foreclosed homes and REO inventory. The choice comes down to less damage over a longer time or more damage all at once. A small loss over time can be absorbed by existing profits on a month by month basis, and while it may be an equal or greater total balance than to take it all at once, a single hit in those kinds of figures would decimate the lender on those notes. Think of it in terms of your own house- If you had to pay for the debt all at once (an expenditure loss of your own personal profits), the chances are you couldn’t do it and if you were FORCED to do it it would wipe you out. Instead, you finance the house for 30 years, and if you pay the whole 30 years you will have paid 2 1/2 times the asking price over the life of the loan- It costs more, WAY more, but it comes in bite sized, easy to chew pieces.

 It’s disclaimer time again! I am a real estate professional with 5 years experience in the industry. I am not an economist. Asking my advice on the state of the economy is like asking a dog groomer to tame a lion. They work with animals, sure, but the groomer is not trained to take on something that big. My opinions are just that, opinions- They come free and are worth every dime you paid for them. Don’t sue me if you read it here and I’m wrong or it doesn’t actually apply to you.

 Let me know if there is anything I can do to help you today!