Boston Fed Finds Lenders Prefer Foreclosure

A fresh report by the Boston Federal Reserve Bank found that servicers showed hesitance to modify mortgages since the foreclosure crisis started in 2007.

Researchers concluded that lenders renegotiated with fewer than 3% of the seriously delinquent borrowers in the report’s sample. Re-default and self-cure risks make renegotiation unattractive to investors, and, as a result, lenders expect to recover more from a foreclosure than a modified loan, according to the report.

If a lender renegotiates with a borrower by reducing the principal balance on the loan, foreclosure can be avoided, which is considered positive for the borrower and the market. But the report explores the key to the appeal of renegotiation: Does it also benefit the lender?

The report finds that it doesn’t, but not because of the hindrance of complex securitization webs. This is surprising given the large losses of foreclosure, but the report cites two risks that make lenders skittish about other alternatives.

More than 30% of delinquent borrowers lift themselves up to current payments without a modification. The report concludes that 30% of the money spent on modification is then wasted on this “self-cured” risk.

The second cost comes from re-default. About 40–50% of all modifications fall back into delinquency within six months, according to the study. For them, foreclosure was simply postponed, the report concludes.

The Boston Fed’s report uses data collected by Lender Processing Services (LPS: 41.88 +0.17%), a provider of mortgage processing services. The data set covers 60% of the US mortgage market.

Write to Jon Prior.