Academic journal article Economic Commentary (Cleveland)

Estimating the Impact of Fast-Tracking Foreclosures in Ohio and Pennsylvania

Academic journal article Economic Commentary (Cleveland)

Estimating the Impact of Fast-Tracking Foreclosures in Ohio and Pennsylvania

Article excerpt

In recent months housing markets have shown real signs of life: home prices, home purchases, and housing starts are up, while foreclosure inventories, foreclosure starts, and loan delinquencies are down. But in states that handle foreclosure through the courts (rather than nonjudicial trustee's sales), the lingering effects of the foreclosure crisis may be costing taxpayers money and dragging down the recovery. In those states, the amount of time loans are delinquent before they enter foreclosure and the amount of time loans spend in the foreclosure process are rising.

Anecdotally, many explanations have been offered as to why this is happening. Loan modification programs may explain some of the increase in duration, as lenders work with borrowers in an attempt to modify the loan while the borrowers are delinquent or in foreclosure instead of proceeding to judgment. State-specific requirements, such as the lender having to produce the original note and mortgage may delay or prevent some foreclosures on delinquent loans. Shrinking budgets may be making it difficult for the courts overseeing the cases or the sheriffs offices overseeing the property auctions and deed transfers to process foreclosures in a timely way. Selective foreclosure, which avoids lowvalue properties, may also be a contributing factor, shifting the costs of those properties from the lender to communities and taxing districts.

These problems are intensified when a home that is in the judicial foreclosure process is vacant. States with judicial foreclosure have longer foreclosure timelines than nonjudicial states. When the home is vacant, the cost of the extended judicial foreclosure process has no corresponding benefit, generating deadweight losses.

Recently, some judicial foreclosure states have passed laws that attempt to "fast-track" foreclosures if the property has been abandoned by the homeowner, and others have begun considering similar fast-track laws. This Commentary explores the economic reasoning behind fast-tracking and estimates the size of the deadweight loss that could be eliminated by creating an effective foreclosure fast-track in Ohio and Pennsylvania, two states in the Federal Reserve Bank of Cleveland's District.

The Judicial Foreclosure Process

Requiring that foreclosures be conducted through the courts is a policy decision that has passionate advocates on both sides of the issue. Those that do require it-judicial foreclosure states-have decided that certain safeguards are required before real property can be taken from an owner by a creditor because of a default on a secured loan or by a taxing authority for failure to pay property taxes. In these states creditors and taxing authorities must proceed through the courts, which make sure they have the right to foreclose and the borrower has no legal defenses to foreclosure.

Legislatures have decided that protecting the rights of property owners is worth the higher cost of judicial foreclosure relative to nonjudicial foreclosure. These costs may change depending on whether homes stay occupied or are vacated by the owners during the foreclosure process. When a home in foreclosure remains occupied, the costs may only include the lost value of the creditor or taxing authority's capital investment in the property (which does not earn a return during the foreclosure process), the litigation costs of all parties to the foreclosure, and the court's time. But when a residential property in foreclosure is vacant, this calculation may change.

When the foreclosure sits vacant, there are additional costs to the creditor or taxing authority due to the accelerated depreciation of unoccupied homes, which are less well maintained and more likely to be vandalized or, in some cases, stripped of metal to sell for scrap. There are additional costs to the community when unoccupied homes create health and safety hazards and cause surrounding homes to lose value. In states that allow deficiency judgments such as Ohio and Pennsylvania, there are potentially further costs to the vacated homeowners, who will be liable for the difference between the price the creditor or taxing authority eventually receives for the home and the unpaid loan amount. …

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