Real Estate & Mortgage Insights

More Foreclosures Create Snowball Effect, Government Programs Not Able to Keep Up

It turns out that the more foreclosures there are, the more likely other people are to consider foreclosure, according to a new study.

There used to be some pretty significant negative social stigma attached to letting your home go into foreclosure. Yet as more and more homeowners walk away from their unaffordable or underwater mortgages, that fear of social shame is lessening, leading more Americans to look at foreclosure as a viable option.

A study conducted by Paola Sapienza of the Kellogg School of Management at Northwestern University found that more than a social stigma, many people actually consider defaulting on a loan to be a moral wrong.

The belief that default is immoral made people 77 percent less likely to consider it as an option. On the other side of the spectrum, 17 percent of respondents say they would walk away from their payments, even if they could afford them, if their home value drops to 50 percent of their mortgage total. And those who personally knew someone who had gone into foreclosure were 82 percent more likely to admit they would do the same if things got rough.

"Our research showed there is a 'multiplication effect,' where the social pressure not to default is weakened when homeowners live in areas of high frequency of foreclosures or know others who defaulted strategically," said one of the study's co-authors, Luigi Zingales of the University of Chicago Booth School of Business.

Other interesting points of the study found that the West and Northeast of the U.S. consider mortgage default much less morally wrong than the other parts of the country, and those who approve of government homeowner bailouts were 12 percent more likely to view foreclosure as immoral.

"As defaults become more common, the social stigma attached with defaulting will likely be reduced, especially if there continues to be few repercussions for people who walk away from their loans," said Paola Sapienza. "This has an adverse effect on homeowners who do pay their mortgages, and the after-effects of more defaults and more price collapse could be economic catastrophe."

And even as social pressure that would keep some people from defaulting lessens, the government programs in place to save troubled mortgages are not having the desired effect, according to a panel of government officials speaking at a conference of the National Association of Real Estate Editors. Although the Obama administration plans call for loan servicers to make mortgage modifications en masse, Deputy Treasury Secretary Seth Wheeler said that due to feeble participation, falling home prices and unemployment, the program "is not performing up to expectations yet." Wheeler mentioned that only 150,000 of these modifications have been performed to date, although the goal is to get 9 million mortgages across the country altered into better terms.

What's more, recent reports show mortgage modifications don't seem to be working in the end. There was a 52 percent rate of re-default reported last fall on altered mortgages.

So what is the answer to stemming the tide of U.S. foreclosures? If there is one out there, neither the government nor mortgage lenders have struck on it yet.

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