Wednesday, June 13, 2012

When loan recourse affects mortgage defaults

Sure, home prices pretty much everywhere have dropped from 35% to 55% or more since the housing bubble burst.  (See, Morgan Brennan, Home Prices Are Stabilizing, Signifying A Housing Market Bottom).   Some reports suggest that home prices may be stabilizing and may even start to recover. Id.   That is supposedly there is a bottom to the real estate market.  “Different markets will bottom and recover at different paces depending on a variety of factors this year, including the availability of local jobs and how fast foreclosures can be processed and reabsorbed into local markets.”  Id.  The ten hardest hit states are (as of March 2012):

1.        Nevada (worst)

2.        Florida

3.        New Jersey

4.        California

5.        Louisiana

6.        Illinois

7.        Rhode Island

8.        Mississippi

9.        Arizona

10.    Georgia

See Lending Tree Announces (in case you're wondering, North Dakota has the best housing market).

See, Andrea Ghent, Recourse and Residential Mortgage Default: Evidence from US StatesYou might think that this would result in lower interest rates in recourse states as the risk to lenders would seem lower, but the study concluded this was not the case. 

What about those worst hit real estate market states?  Do limits on lender recourse prime a market for greater risk-taking by home buyers?  Perhaps not.  A good study on the comparison of state laws on recourse by lenders was done by James Orlando, OLR Research Report: Comparison of State Laws on Mortgage Deficiencies and Redemption Periods (Revised 12/9/11).   My quick read suggests that the top ten states hardest hit have mixed regulations when it comes to recourse or non-recourse mortgages.  So, perhaps a hard hit real estate market is just that.  The non-recourse will surely help borrowers who need to default (somewhat of a mini-bailout of sorts).  Perhaps the strategic defaulters get a bit of a headwind in these states.  There doesn't seem to be enough data to suggest, though, that the availability of a non-recourse loan was a substantial factor in the decline of the markets in the hardest hit states. 

My suspicion is that most home loan defaulters don't have the assets available to lenders who would pursue a deficiency judgment even if they could under state law.  If defaults are higher in non-recourse states, though, it would seem that either: (i) those in difficulty find it easier to let go where there is no recourse; or (ii) those who can pay act more opportunistically in a way that increases the number of defaults.  Even without recourse, the homeowner who opportunistically walks away from the mortgage does not get a complete free pass due to the impact on their credit report.  And, as Brent White (University of Arizona) has argued, the shame and guilt of walking away is often enough to deter many homeowners.  See, Underwater and Not Walking Away.  So, perhaps the local law doesn't have much impact after all.   

- JSM   

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