According to realtytrac.com, 300,000 homes went into foreclosure last month. Bloomberg reports that the U.S. delinquency rate rose to 9.4% and foreclosures rose to 1.37%. According to Moody’s Investor Service, 42 percent of outstanding 2006-vintage subprime loans are at least 60 days delinquent, in foreclosure, or held for sale. As we all know, the housing crisis and rising unemployment rates have served to make it difficult for many Americans to pay their mortgages on time, and the result is that many of the nation’s home owners are in dire straights. The problem is bad, and banks need to change the way they modify mortgages if they hope to provide adequate assistance. They are now concentrating on fixing disasters as they arise rather than preventing them in the first place.
With so many people in financial trouble, mortgage lenders like Bank of America, Wells Fargo, Wachovia, Chase, and Citigroup are finding themselves too understaffed to deal with these excessive defaults. Given that a bank only has so many resources to extend to their borrowers, the dilemma becomes who to work with first. Basically, the bank has to perform a kind of triage, like in a hospital, to determine which of their clients demands immediate attention, and which clients can wait. The lender faces different kinds of repayment problems. Specifically, they have people who cannot repay and who are defaulting right now, and people who have done everything in their power to repay (tapped into savings, changed their lifestyle, etc.) but who cannot sustain their payments any longer; they have not defaulted yet but soon they will. According to a survey by ProPublica, it seems that most major lenders have been focusing on borrowers who are most delinquent at the expense of borrowers that are current but will quickly become delinquent unless they get help.
Mortgage lenders’ current prioritization encourages people to default rather than to do whatever is in their power to continue making payments. When it becomes preferable to not pay one’s bills rather than to be a responsible borrower, the system is in trouble because it is punishing the right kind of behavior and rewarding the wrong kind. Why even bother trying to make the effort to pay on time if you are at significant risk of defaulting in the near future? You can only expect significant help from your mortgage lender, given their current practice, only after you have defaulted.
Of course, one should not discount the economic and psychological effect of this practice on the borrowers themselves. Late payments make coming back from whatever economic problem is being faced at the moment just that much harder, given their impact on credit scores and fees. It’s always easier to divert disaster than to deal with one that has happened. According to a joint study by the Office of Comptroller of the Currency and the Office of Thrift Supervision, 43% of modified loans were delinquent again in 8 months. Furthermore, there is the general stigma of simply not being able to pay bills. One wonders just how much a sense of defeat contributes to the borrower’s inability to pull themselves back from their financial troubles.
Clearly, the mortgage lenders are operating through an intuitive model. Human nature is to help the person who needs the most help first, but as it turns out this is not the best way to maximize the number of people that get effective help. The current practice encourages borrowers to default and it lets people who are slipping into crisis simply go. The bank’s effectiveness diminishes as it must put more resources in helping those that have defaulted than it would if it had prevented their defaulting in the first place. The best way for banks to maximize their effectiveness is to focus their resources on prevention and not on borrowers that are most delinquent. It is a tough choice, but it is the right choice when faced with limited resources.