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Wednesday, January 19, 2011

Incentives and Factors Influencing Foreclosure and Other Loss Mitigation Outcomes

Darryl E. Getter
Specialist in Financial Economics

Since 2006, the percentage of mortgage loans that are seriously delinquent, including defaulted loans and foreclosures in inventory, has risen. One option for resolving a mortgage default is foreclosure. Foreclosure, however, is costly for borrowers that lose what might be the largest asset in their portfolios; for lenders that may not be able to recoup the outstanding loan amount, legal fees, lost revenue, and maintenance cost until distressed property is sold; and for neighborhoods that may endure long-term vacancies, which may reduce nearby property values.

A less dramatic option for borrowers may be loan modifications that would result in more affordable mortgage payments. Many distressed borrowers, however, have not been able to obtain loan modifications and avoid foreclosure despite recent congressional initiatives. Given that foreclosure appears to be used extensively to resolve rising loan defaults, an overview of servicer incentives and other factors that can influence the loss mitigation options made available to distressed borrowers may provide a useful context for understanding these observations.

This report begins with an overview of servicing and a summary of the typical array of loss mitigation options that servicers may offer distressed borrowers. It then summarizes and discusses the incentives that may guide the decisions of servicers. Regional house price movements and unemployment trends are important drivers of mortgage repayment problems and loss mitigation outcomes, which are discussed in the following section. Such regional macroeconomic factors determine whether troubled borrowers would have sufficient income or collateral, which affects the feasibility of a loan modification. A case study on the performance of Texas mortgages during the recent crisis further illustrates the importance of regional factors for influencing loan repayment problems and loss mitigation outcomes. Greater detail about the foreclosure process and the data sources tracking foreclosure are contained in appendices.

Date of Report: January 11, 2011
Number of Pages: 22
Order Number: R41572
Price: $29.95

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