Home Values Affect Foreclosure Rates More Than Defaults

Foreclosures indicate more about changes in past home values than they do about the current economy or mortgage underwriting standards.

The Washington Post is reporting that mortgage delinquencies reached record highs. Delinquencies resolve in three ways.

1. The homeowner pays the arrears and the mortgage becomes current.


2. The mortgage lender forecloses on the home.


3. The homeowner sells the home and the proceeds pay off the mortgage including all arrears with a possibility of excess fund available for the selling homeowner.

Homeowners become delinquent for two reasons.

1. They had the ability to afford the monthly payments but subsequent events occurred which changed their ability to pay. The common events for mortgage delinquency are unemployment, excessive medical expenses, death of a wage earner, divorce, or a reduction in income.


2. The second reason is a household that never was in a position to pay its mortgage. It cannot manage its total debt, gets overextended and does not have enough income to pay all its debts. Eventually, it defaults on the mortgage even without any changes to total household income.

Due to the current recession and the high unemployment, many homeowners with mortgages have lost their jobs or seen a decrease in their income. Without a positive change to income, these homeowners will default on their mortgages.

If home values had not declined and home sales were strong, these households plus the overextended households would sell their homes, pay off the mortgage, pocket any excess funds and move into a more affordable space. Some possibilities for increasing affordability are to move in with relatives, to rent, or to buy a less expensive dwelling. In these cases, defaults would occur without foreclosures.

With the sharp drop in home values, many homes have mortgages in excess of their sale prices. Homeowners cannot sell their homes because they owe more than they would receive as the sales price. Additionally, many homes are not selling or are taking a long time to sell. While a home is up for sale, the arrears on the mortgage accumulate and increase the debt of the homeowner.

The only viable option, for a defaulting homeowner with a house value below the mortgage amount, is foreclosure. A homeowner sale would not payoff the mortgage. Foreclosures result from an inability to pay coupled with a sales price below mortgage value. There is no data to indicate that homeowners with homes worth less than their mortgages are walking away from mortgages that they can afford to pay and letting the home go into foreclosure. There are anecdotes that some people are not paying a few months of mortgage payments to qualify for mortgage modification programs.

Home values more than high unemployment affect the number of foreclosures. If home values had not declined, defaults would result in more home sales and fewer foreclosures.

The high foreclosure rates we are seeing during this financial crisis and recession is more a product of the decline in home values than any other factor. Even if unemployment and the economy improve, foreclosures will remain higher than normal until home values stabilize or increase.