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Foreclosure Moratorium

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Posted On: 07/15/2009

Q:During the past year a number of states, lenders, Fannie Mae, Freddie Mac and others have started foreclosure moratoriums. Why not just place a “hold” on all foreclosures until the real-estate markets return?

A: Moratoriums have a lot of appeal, but they’re actually complicated and maybe not something you want.

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Thomas Jefferson said long ago “that banking establishments are more dangerous than standing armies; and that the principle of spending money to be paid by posterity, under the name of funding, is but swindling futurity on a large scale.”

A lot of people probably think Jefferson was too generous in his assessment of banking. To prevent the banking and brokerage excesses we’re supposed to have regulatory systems to protect the public interest. It failed.

If we had a small number of defaults then a foreclosure moratorium might be a useful option, but in the face of millions of homes at risk and the downward pressure on home values, a foreclosure moratorium may actually make things worse. That’s not what most folks want to hear, but it’s a reality.

With a real-estate loan we have a borrower and a lender. The needs of a distressed homeowner who lives down the street are easy to see and understand while big lenders located far away are often seen as callous and uncaring. These perceptions very much flavor discussions regarding moratoriums, but perceptions are not the whole story.

A mortgage is a contract. In exchange for money today homeowners agree to repay loans over time and with interest. Since the borrower got the money up front there’s very little to compel repayment except for the potential loss of the property. While lenders talk about honor and credit ratings, their real leverage comes from the ability to foreclose.

Let’s say that Smith has a $200,000 mortgage and defaults. What happens next? Depending on the jurisdiction where the property is located the foreclosure process can take anywhere from a few weeks to more than a year.

Let’s also say that for whatever reason Smith cannot make his mortgage payments, but even if the lender goes to court there’s a six-month foreclosure moratorium. In an ideal world Smith and the lender should use the moratorium period to bring the loan current or modify the financing so that a foreclosure is avoided.

Unfortunately, the world is far from ideal. If catching up on the mortgage is not feasible, then Smith may simply stop making payments, live mortgage-free for a few months and use the money he saves to bulk up his finances.

But what about you? If Smith lives on your block what will happen to his house? What will happen to local home values -- especially your home value?

If we have moratoriums then foreclosure numbers will go down for a period of weeks or months. The classic example is Maryland. In April 2008 it increased the time required for a foreclosure by approximately 135 days -- about four and a half months. Figures from RealtyTrac.com show that in April 2008 the state had 2,345 in May after the new rules took effect.

What impact did the moratorium have on home values? By April 2009 Maryland had 3,613 foreclosure filings -- but homes prices were down 17.2 percent compared with a year earlier according to the Maryland Association of Realtors.

While moratoriums prevent foreclosures they do not prevent defaults. Courts and lenders get backed up with paperwork when moratoriums first take effect, but in time foreclosure counts rise and so do lender inventories of defaulted properties. These bloated inventories hold down home values because buyers know that they have the option of buying foreclosed properties at discount. These bargain-basement sale prices are known to buyers and help set the asking prices for all neighborhood homes.

The end result of foreclosure moratoriums: huge numbers of foreclosed homes held by lenders that remain unsold and large numbers of distressed properties not even for sale.

Peter G. Miller is the author of The Common-Sense Mortgage and a veteran real estate columnist. Have a question? Please write to peter@ctwfeatures.com.

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