The average age of a loan in foreclosure hit 492 days in October, and appears as if it will only loom ever-longer in the months ahead. But it’s how we got here that is the real untold story: One that is as much about an overwhelmed loan servicing function as it is about a legal system that has now become clogged with challenges from troubled borrowers.
Let’s start with real-world implications. The average borrower in foreclosure has been stuck in the default pipeline for more than 16 months, according to Lender Processing Services
[stock LPS][/stock], without making any sort of payment on their mortgage. That's well over a year, with some states even averaging north of this number. No wonder servicers are increasingly halting principal and interest advances, deeming loans unrecoverable. At that level of severe delinquency, there is simply no cure that can restore a loan to performing.
Here’s why: Consider that the average carry cost of a home in foreclosure is 1.5% of unpaid principal balance per month, on average, a figure I’ve been given by various servicing executives. For a $200,000 loan in foreclosure, that amounts to more than $48,000 in accumulated carry costs given the average age. That’s roughly a quarter of the entire original indebted amount.
(If you wondered how loss severities above 100% are materializing on liquidated debt, by the way, this is how you get there.)
To hear some say it, the best overall solution is to forgive principal on the original loan for delinquent borrowers. But how much should be forgiven, in practice? Even if an investor were to agree to forgive principal on 25% of the unpaid balance in our example above, at best the borrower ends up right back where they started. Given that the borrower couldn’t afford a similar level of debt to begin with, I’m not sure how much of a comfort this is supposed to really be to anyone.
The same LPS data shows that the average age of a delinquent loan that is more than 90 days in arrears but not yet in foreclosure stands at 318 days. This means that the same challenges apply to any severely delinquent borrower, whether they are already in foreclosure or not.
So investors tend to prefer foreclosure, once the process has begun. This really shouldn’t be the surprise many have made it out to be.
In many cases, too, once a loan is deemed unrecoverable there is no other option but to foreclose. For now at least, principal forgiveness remains a last option in the loss mitigator’s tool box — meaning investors and servicers tend not to consider it an option until other options have been exhausted; the reasons here are myriad and include moral hazard. Regardless, it’s clear that taking the time needed to exhaust all other options in the current environment is enough by itself to put investors into a position where foreclosure becomes the most viable option.
A negative feedback loop
The Wall Street Journal recently zeroed in
on the 492 days in foreclosure figure, noting that the length of time it’s now taking to foreclose is a "meaningful incentive" for other borrowers on the margin to choose to default, as well. Which it is.
All of this begs an important question: How did we get here?
Part of the answer, of course, is that servicers have been and remain overwhelmed. Many big-box servicers have become victims of a servicing model that never contemplated a surge in defaults the likes of which are now being absorbed — nor does the current servicing model provide them with appropriate incentives for reaching an outcome outside of a foreclosure.
That said, the servicer’s job is to work in the interest of investors or the trust; and as we’ve seen, it’s actually true right now that foreclosure is in many cases the best outcome for that investor.
Government intervention in an attempt to solve for the incentive problem (via HAMP and other initiatives) didn’t help, but instead dramatically increased the complexity and overhead burden expected to be borne by servicers. In other words, it made an existing problem progressively worse. Combine that with a horribly defined set of eligibility criteria, and you have the recipe for false and unfulfilled hope among tens of thousands of distressed homeowners nationwide.
Thanks to HAMP, servicers now face significant litigation risk from disappointed borrowers who saw the government program as a cure-all for their financial ills; of course, this litigation won’t be aimed at the federal government but at the ‘evil’ lender/servicers that were forced to implement a flawed program.
I find it ironic within this context, by the way, that so many financial commentators are now content to peg the nation’s banks with somehow willfully manipulating their captive and third-party servicing platforms for their own financial interests. If anything, what the robo-signing scandal and other challenges surrounding HAMP implementation should have illustrated for everyone is that many of the nation’s largest servicing shops can’t even walk and chew gum at the same time.
Beyond misinformed politicians implementing bad policies, and beyond the clumsy ineptitude of much of the servicing industry itself, one other factor has helped create the foreclosure backlog we're now faced with: a lionized consumer bar, which for better or for worse has made the process of foreclosure much more complex and time consuming (not to mention more hostile).
Foreclosure defense has become a cottage industry unto itself during these past three years, and for good reason, too: the number of borrowers defaulting has mushroomed. The result has been some pretty contentious courtroom cases. Consumer attorneys tow the line that they’re protecting the public interest and the public’s right to due process — which in many cases I believe they are, as the robo-signing scandal has clearly demonstrated. But it is equally true that nobody was really willing to protect this interest until it actually became profitable for an attorney to do so.
"I’ve often wondered how our society could have so many attorneys all wanting to make six figure incomes," opined one lawyer I spoke with, who specializes in representing banking clients and requested anonymity. "Using owners of housing secured debt as a deep pocket is a very bad idea socially, but it’s been good business for anyone doing legal work. We’ll be busy on both sides of this thing for years to come."
The end result? 492 days, on average, for every household in foreclosure — and still growing.
Paul Jackson is the publisher of HousingWire and HousingWire Magazine. Follow him on Twitter: @pjackson