Unemployment To Blame For 'Unaffordable' Mortgage

By Margarita Nahapetyan

Boston Federal Reserve Economists have found that it is unemployment and not high interest rates, that is to blame for missed mortgage payments.

The economists took a critical look at the nation's foreclosure problem, and found evidence that directly challenges what many have assumed is common knowledge - the idea that borrowers are stuck with 'unaffordable mortgages,' and need strong government intervention in order to make their mortgages more affordable.

Borrowers are more likely to be late with their payments because they have lost their jobs or because the prices of their homes have fallen, rather than because of tough terms on their mortgages, wrote in a paper Boston Federal economists Christopher Foote and Paul Willen, Atlanta Federal investigator Kristopher Gerardi and Lorenz Goette, a professor at the University of Geneva. And loan modifications are not necessarily a better deal for investors, the experts said. Their investigation revealed that policies that directly help homeowners overcome setbacks such as losing their jobs may be more effective in combating foreclosures.

Normally, foreclosures are a result of recessions - people lose their jobs, after that they lose their homes because they cannot afford anymore to make their mortgage payments. It seems as though the society is now right in that stage after the loss of nearly 4 million jobs over just the past half a year. The paper's authors do not agree with the idea that mortgage "affordability", stated in the research as the borrower's DTI ratio at origination, is an exceptionally bad predictor of a future default. "While a higher monthly payment makes default more likely, other factors, such as the level of house prices, expectations of future house price growth and inter-temporal variation in household income, matter as well," they wrote. "Movements in all of these factors have increased the probability of default in recent years, so a large increase in foreclosures is not surprising."

The findings pose a challenge to the thinking behind a White House plan that has been announced in February. According to the $75 billion plan, as many as 9 million families would be given the opportunity to refinance or modify their mortgages. President Barack Obama's administration has made loan modifications a central priority in its efforts to deal with the housing crisis. According to the one of the most influential strands of thought, the negative consequences of the crisis can be diminished by changing the terms of 'unaffordable' mortgages," the experts wrote. But policies that concentrate on loan modification "face important hurdles in addressing the current foreclosure crisis," they added.

The economists suggest that the government could consider alternative options, such as replace part of an individual homeowner's lost income caused by unemployment, through loans and grants or help those in the worst situation to become renters through short sales or other procedures. In addition, investors will not necessarily gain any benefit if foreclosure is avoided, they said, and that could help explain the relatively small number of loan modifications at present time. Estimates that total gains for investors from modifying rather than foreclosing can climb up to $180 billion, may not take into consideration a number of main factors. Investors can lose money when they modify mortgages for borrowers who would have paid it back in any case. Borrowers with modified loans may default again at a later time, especially if the reason they were driven to default remains, the economists said.

The paper has been posted on the Boston Fed's Web site earlier this week.