Foreclosure Mediation

A number of states and localities--OH, CT, NY, Philly among them--are experimenting with foreclosure mediation as an alternative way to settle foreclosure disputes. Of course from a lender's perspective there is no dispute--the contract was broken and foreclosure is the avenue to seek remedy. But the reality is foreclosure takes a long time and is costly to the lender and borrower. Some share of borrowers could remain in the loan if the loan terms are modified. How the modifications happen really matters, and mediation prior to foreclosure could help make that happen.

The mediator is a 3rd party, typically someone with legal training but outside the courts. Both sides (borrower and lender) have to make good faith efforts. Using a 3rd party a solution (modification or sale of home w/o foreclosure) could be found. It saves money and the potential harm to neighboring properties, not to mention the borrower and his or her credit record.

How would it work? Lenders could be required to offer mediation before foreclosure can proceed. Borrowers have a time limit to respond. Then the mediation has some limited time to be completed. Ideally the loan is restructured to avoid foreclosure or the borrower buys time to market and sell the home privately.

The critique of mediation is borrowers may be at a disadvantage. It is becoming clear not all loan mods are the same. A loan mod that moves fees to the final payment in 20 years and lowers the interest rate for a few years has less than a 50-50 shot at success. A mod with principal reduction has better odds - maybe as much as 80% will succeed. Mediation may result in naive borrowers agreeing to mods with weak terms and few net gains. One could imagine discretion on the part of lenders resulting in disparate impacts by race, income, location or in all three dimensions.

Enter the role of education and counseling. Prior to the mediation the borrower has to so some homework. Ohio's program has such a requirement. How well borrowers can be trained to explore their options is an open question, but it beats going in unarmed with a sophisticated lender.

There are lots of problems - like dealing with high volumes of foreclosure filings, getting borrowers to pay attention at all, compensating mediators and counselors, getting lenders/servicers to create mods that really can succeed given investor and legal issues with mortgage securities--just to name a few.

To be sure, if a mortgage cram down bankruptcy provision is passed at the Federal level, lenders may seek alternatives such as mediation with open arms. And anything that attempts to get the borrower to take action before the auction is socially valuable, even if the mediation does not result in a mod. Given the slow pace to restructuring individual mortgages we have seen so far, the mediation approach may have potential.

More Incentives to Borrow

The stimulus package contains so much it is hard to parse it all out. But there are several provisions to encourage consumer borrowing - notably to buy a first home and a car. The first-time buyer tax credit for homebuyers is actually an oldie but goodie. Every economic slowdown the Home Builders and allies promote such a credit. The tax deduction for 1 years worth of car loan--and deduction of sales tax for an auto purchase is a new one. Certainly it makes borrowing to buy a car more attractive, especially if you can pay off the loan in year two and avoid all that non-tax advantaged interest. Will consumers take the bait? Will lenders gin up loan volumes, or just make loans to prime credit borrowers? Don't be suprised if consumers and lenders still are conservative. If not, then the lessons of the last two years will have been too quickly lost. Ideally lending will return slowly and carefully on both the supply and demand side. There could be a real danger to an artificial boom...another lesson which may all to quickly be forgotten. We'll just have to wait and see.

Follow up: for fun (and sadly true):
http://www.hulu.com/watch/1389/saturday-night-live-dont-buy-stuff

Burn the Mortgage

Back before subprime loans and the mortgage meltdown...before MBS and CDOs...there was a time when people actually set a goal of paying of their mortgage and then burned the note in celebratory fashion. The mindset was that debt was bad and getting the home paid off was a great success.

In the last 2 decades a parade of experts have created lots of reasons not to pay off the mortgage. First, rates were cheap. You'd have to be silly not to borrow at 6% if the S&P 500 returned 10%. Second, mortgage interest is tax deductible. The after tax cost of borrowing is even lower than the note rate. And it feels good to take that fat income tax deduction. Third, carrying debt into retirement is no big deal since you can always work and your investment income will be more than adequate anyway.

The mortgage industry, from street level brokers to Wall Street analysts and DC lobbyists, embraced the idea that not only should Americans carry a mortgage, they should refinance to get a lower rate, take out equity for consumption or even lengthen the term to reduce payments.

Maybe its time for consumers to turn their backs on the mortgage. Here are a few reasons.

(1) Paying off the mortgage is like insurance. Yes, you could in theory work or cash in investments to meet payment obligations, but what if you cannot work and/or your assets are depreciated? Paying off the mortgage protects you from getting trapped. In effect the house pays your rent for you no matter your situation once you pay off that note. Plus if you put more equity in going "under water" is less of a problem.

(2) The tax benefits are not as great as you may think. Interest is a sizable portion of the payment for the first few years and then starts to decline faster over the term of the loan. The property tax deduction remains a significant value even if interest is no longer paid. Several economists have shown eliminating the mortgage interest deduction would have minimal effects on the market (in effect all buyers and sellers expect the deduction and prices adjust accordingly), although it would need to be carefully phased in.

(3) Paying off the mortgage creates a constraint to spending. If you have your money tied up in your house and refuse to take out home equity, you won't be lured into spending that money. Behavioral constraints are important for most consumers and this is a simple way to create one.

(4) Having a mortgage takes your time and energy...and money You have to manage the payments and deal with the lender/servicer, etc. Plus remember you are paying interest. All that is a cost you can avoid. Not to mention any anxiety related to knowing you owe another payment next month. And then refinancing incurs even more real transaction costs. And if the refi is not for a term shorter than the remaining years in the loan, it just lengthens out the time people are in debt.

Imagine a consumer movement that rose up to reject serial refinancing and worked hard to pay off every mortgage early. Think how much more stable consumers, housing, maybe even the economy might be...

But alas, its seems unlikely mortgage burning parties are going to make a comeback. What might help? End the mortgage interest deduction, at least for non-first time buyers and for all forms of home equity loans. Require loan applicants for all refinance loans that are not for a shorter term than their existing loan to attend mortgage counseling. And celebrate those who pay off their loans.

As it is about 24 million of the 75 million home owning households in the US owns their home free and clear with no mortgage. The majority are not rich either - with incomes under $50,000. At the very least they can sleep tonight knowing they are not at risk of foreclosure.