Wednesday, February 11, 2009

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.

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