While a mortgage is a financial contract between a borrower and a lender, when a foreclosure occurs there are repercussions that impact parties external to that contract, i.e. neighbors, tenant, and whole communities can suffer. In a Public Policy Paper prepared for the Federal Reserve Bank of Boston titled When Does Delinquency Result in Neglect? Mortgage Delinquency and Property Maintenance, Lauren Lambie-Hanson looked at the timing of one foreclosure side effect or externality, reduced upkeep, using conditions reported by constituents in the City of Boston.
She used four sets of data, public records data on property transactions, mortgages, and foreclosure starts for single-family, 2-3 family and condo properties from the Massachusetts Land Court, loan-level data from CoreLogic on securitized subprime and Alt-A mortgages, which provided both legal data on the loans and monthly information about when loans became delinquent, entered foreclosure, and the dollar value of losses experienced by lenders when properties were sold which helped to identify short sales. The MLS Property Information Network provided real estate sale listings which helped match up data from the other two sources.
The final database was from the Constituent Response Management System (CRM) which has been maintained by the City of Boston since October 2008 This database includes reports made by phone (calls or text messages), internet, smart phone application, and in-person visits which range from requests for recycling bins or pothole repair to complaints about graffiti, illegal dumping, and abandoned properties. Each report is dated, refers to a specific address, and includes a detailed description and standardized category for the request.
Compared to most large cities Boston maintained a relatively robust housing market during the recent crisis. Prices bottomed out in 2009 at 82 percent of peak values. City-wide there were about 3,400 foreclosures of single-family, 2-3 family, and condo properties. There were 1,200 completed short sales between 2007 and 2011. Seventy percent of the distressed sales have been concentrated in five of Boston's neighborhoods.
The complaints in the CRM data-base tend to originate from residents of neighborhood, especially those particular to a specific property. Neighbors complain about overflowing trash barrels or squatters, tenants of the subject property about problems like lead paint.
When the CRM dataset was matched with CoreLogic data thee was a disproportionate incidence of complaints when properties are bank owned. Listed and non-listed REO properties make up 1.6 percent of the monthly observations, but 5 percent of the observations where complaints are logged. Similarly, borrowers in foreclosure make up 15 percent of the sample, but 21 percent of observations with complaints. On the other hand, monthly observations for borrowers who were current, 30-60 days delinquent, and even seriously delinquent (90 or more days) but pre-foreclosure received disproportionately low rates of complaints.
Interestingly, there appears to be no relationship between equity and property upkeep, as evidenced by neighbor and tenant reports to City government. It is not possible to conclusively identify when an owner became a candidate for a short sales, but using MLS data as a proxy, 1.4 percent of properties were actively listed in the MLS as short sales and constituted nearly 3 percent of the monthly complaints.
The author found evidence that a borrower's mortgage status (or a property's status as bank owned or resold to a new owner) is correlated with the probability that the property is the subject of a complaint or service request made by a constituent to local government. Essentially, beginning with the date when a borrower becomes seriously (90 or more days) delinquent, the incidence of complaints begins to rise. During the first year in default, a borrower is, on average, 1.35 times as likely to be the subject of a complaint as when that borrower was current on his mortgage. After spending a year in default, the odds increase to more than 1.7. However, serious delinquency seems to be tied to a greater incidence of complaints only when a borrower is in foreclosure. Once a borrower is in foreclosure, he is over 1.8 times as likely to receive a complaint as when he is current on the mortgage. The effect appears to grow as a borrower spends longer in foreclosure although the difference in the estimates is not statistically significant.
There are indications that properties are particularly susceptible to complaints after becoming REO. Specifically, prior to listing the REO properties for sale, lenders are more than 2.8 times as likely to receive a complaint as when the borrowers were making their monthly mortgage payments. After listing the properties, the odds increase to over 3.8.
These general relationships tend to hold for each type of complaint or request made. "Poor condition" complaints, the most common, reference topics like water leaking into an apartment, broken windows, or a combination of several types of problems. REOs are particularly prone to these types of complaints, receiving them, on average, at over four times the rate of properties owned by borrowers who are current (but are observed to default at some point in the dataset).
While these patterns hold for all property types they are particularly strong for single-family properties; the typical single-family property is over nine times as likely to receive a complaint while REO than if its owner were current on his mortgage. Similarly, for single-family owners there is a greater average difference between a borrower's property upkeep while he is current and while he is in foreclosure; he is nearly 3.8 times as likely to receive a complaint while in foreclosure as when making payments regularly.
Complaints come from both neighbors and tenants. If a property is occupied, all else equal, it may be more likely that the City receives a report about it. Tenants of foreclosed properties, particularly those living in units recently bought back at auction by lenders, may not know whom to contact about property problems so call the city. Constituents may feel less hesitant to report code violations and other infractions to the city if a property is lender owned or, before the "for sale" sign is posted by the bank, residents may not even realize a property is bank owned.
The author found no consistent evidence that borrowers with less equity are more likely to be the subject of a complaint than borrowers who have more equity. However, owners who default and have high levels of equity ought to be rare, since they should be able to sell their properties, or possibly even refinance, when financially distressed. Also, if borrowers with a lot of equity are seriously delinquent, that is a signal that they may be experiencing additional problems above and beyond ordinary circumstances that might trigger a default.
Given that property conditions appear to suffer most when properties are REO-but do not necessarily fare poorly when a home is held by an owner with negative equity-a natural question is whether properties sold short suffer less disinvestment than properties sold through foreclosure. Owners who have listed their properties for short sale are about 1.4 times as likely to receive a complaint than are owners who are not pursuing a short sale. But owners who are attempting to sell their properties short do not seem to be representative of the full sample of distressed borrowers as they are almost twice as likely to ultimately lose their homes to foreclosure. Even after restricting the sample to just those borrowers whose lenders have started foreclosure proceedings, there is still a disparity in foreclosure rates between those who did and did not attempt short sales (17 percent and 13 percent foreclosure rates, respectively).
Are short sales and foreclosures equally harmful to neighborhoods? The period of default is longer for completed foreclosures than short sales; 25 versus 21 months. Furthermore, foreclosures are held by lenders for an average of eight months, meaning that in the typical foreclosure, properties spend a year longer in "ownership limbo" than in the typical short sale. Then, as pointed out earlier, properties appear to suffer worse upkeep when they are bank owned
The author attempted to control for other variables such as a greater propensity for neighbors to report problems as its stock of REO properties grows or that not all complaints are necessarily serious or tied to the delinquency or REO status of the property. Ultimately, however, each complaint must be investigated by the city so complaints are a relevant measure of the drain on public resources of mortgage distress and foreclosure.
The findings suggest that distressed properties are most problematic when held by banks, both before and during lenders' attempts to sell the properties. The author makes the following recommendations.
- While lenders often work to bring properties up to code to enable sales to buyers who require FHA mortgage financing, perhaps greater bank accountability for properties is needed.
- Finding the parties responsible for REO property upkeep can be challenging, even when properties have a designated real estate agent. The introduction of some type of publicly accessible information such as recently initiated on-line by Zillow or the foreclosure registration ordinance in Boston may increase public awareness about the ownership status of nearby properties and lessen banks' abilities to "hide in the shadows" while their properties become community nuisances.
- Longer periods in serious delinquency and foreclosure generate negative externalities for neighbors. Policymakers should consider this finding when designing well-intentioned policies that lengthen the foreclosure timeline and thus the time properties are in ownership limbo.
- Short sales are shown to result in shorter durations or ownership limbo even though they do not appear to receive better upkeep when owned by a borrower pursuing a short sale.
- The paper leaves open the question of how properties fare after being resold to third-party buyers and the author recommends further studying the role of investors and homeowners in purchasing foreclosed properties and stabilizing neighborhoods.
