Study: Defaulters Having More Trouble Returning to Mortgage Market

A study released by the ""Federal Reserve Bank of San Francisco"":http://www.frbsf.org/index.html revealed borrowers who defaulted on their mortgages in the last several years tend to stay out of the mortgage market for much longer than other borrowers.

[IMAGE]

According to research associate William Hedberg and senior economist John Krainer, only about 10 percent of borrowers with a prior serious delinquency regain access to the mortgage market within 10 years of their default. Borrowers with prior mortgages in good standing, on the other hand, return much faster--about 35 percent are back in the market after 10 years, based on the researchers' calculations.

What's more, Hedberg and Krainer note that while prime and subprime borrowers largely have the same borrowing experience immediately following a foreclosure--""probably because the borrowers we label as prime are no longer in that category after foreclosure,"" the researchers remark--borrowers who are able to salvage their credit score return to the market at a remarkably fast rate compared to those who stay in the subprime group.

The report also examines the rates at which defaulted borrowers from 2001, 2003, and 2008 return for a new mortgage. The 2008 group has shown an extremely slow return rate, with roughly 5 percent returning to the market after four years (compared to about 17 percent for the 2001 default vintage group and 25 percent for the 2003 defaulters). Hedberg and Krainer say the low rate of return for the 2008 group could be related to a drop in demand.

""In the 2001 and 2003 cohorts, there was very strong overall demand for housing, as evidenced by the strong run-up in the rate of homeownership during the 2000s,"" they say in the report. ""But the Great Recession that Began in 2007 was much deeper than the 2001 recession, and uncertainty about jobs or future income prospects may have made people unwilling or unable to demand housing at the rate seen after previous recessions.""

However, the 2008 group's slow return may also reflect tight credit supply. As the researchers note, ""the mortgage finance system was severely disrupted during the financial crisis of 2007-08."" Defaulters in the last few years have shown similar rates of return to the market, suggesting more restrictive loan terms.

One piece of information the researchers found surprising was the fact that judicial or nonjudicial foreclosure law has little effect on return rate. Roughly 10 percent of defaulters in nonjudicial states are back in the market after 10 years, while that rate is about 12 percent for defaulters in judicial states.

""Judicial foreclosures ... are much more time-consuming and costly than nonjudicial foreclosures, in which the lender can serve the borrower with a notice of foreclosure and proceed to reclaim the house,"" the report says. ""All else equal, borrowers in judicial foreclosure states would be expected to be denied credit for longer periods.""

While Hedberg and Krainer ""treat access to credit as a decision more or less made by lenders,"" they acknowledge that other factors can influence borrower presence. For example, a borrower who has gone through the stress of defaulting may be unwilling to seek credit again.

In addition, important institutional restrictions can also slow a borrower's rate of return following a default or foreclosure. Because people with ""a major derogatory event on their credit history"" typically can't qualify for a conventional loan securitized through Fannie Mae or Freddie Mac for some time, many defaulters are unable to return for half a decade or longer. Of course, that doesn't necessarily stop lenders from making loans.

""A lender has the option of making the loan and keeping it on its own balance sheet instead of selling it to one of the GSEs,"" the report says. ""However, the GSEs own or guarantee the vast majority of new mortgages, which makes the restriction a powerful barrier keeping defaulters from returning to the market.""