Short Sales and Foreclosures – Good for the Economy?
By: Robert Nagle & Stuart Pack
Although it may seem counterintuitive to state that short sales and foreclosures are good for the economy, recent research has disclosed that government policies designed to encourage mortgage modifications may actually increase unemployment.
A borrower whose home is underwater typically has four options. Likely the most frequently chosen option of most borrowers is simply to do nothing; in other words, if the homeowner can afford to continue the current monthly mortgage payments even if it is economically disadvantageous to do so, most homeowners will do so. The second option is a mortgage modification. Government programs, such as the Home Affordable Mortgage Modification Program (HAMP), are intended to incentivize lenders and homeowners to modify a home mortgage. Typically, such modifications involve reducing the current monthly mortgage payments by way of a reduction of the interest rate or an increase in the term of the loan, but rarely any principal reduction. The third option is a short sale of the home where the lender agrees to accept the net sale proceeds in return for release of the lien of the mortgage even though the proceeds will not cover the outstanding balance due under the mortgage (the homeowner should always be certain that in addition to releasing the mortgage, that he is also released from personal liability on the mortgage loan). The fourth option is simply for the homeowner to walk away from the mortgage which, when combined with Arizona’s anti-deficiency laws, eliminates any risk the homeowner will face personal liability for any deficiency (of course, personal liability for the deficiency is dependent on how Arizona’s anti-deficiency laws are applied in each situation and competent legal counsel should be consulted before choosing this option).
As Conor Dougherty of the Wall Street Journal reported in his August 19, 2011, blog post, a new research paper entitled “Labor Market Dysfunction During the Great Recession” by Kyle F. Herkenhoff and Lee E. Ohanian, both professors of Economics at UCLA, has come to the conclusion that by reducing home mortgage payments people are motivated not to move from their home to better labor markets. As the paper points out, most economists believe that this reduction in mobility by homeowners increases unemployment because people do not give themselves the opportunity to work in a place where jobs are more available. Herkenhoff and Ohanian have come to the conclusion that “modifications raise the unemployment rate by about 0.5 percentage points, and reduce output by about 1 percent, reflecting both lower employment and lower productivity, which is the result of individuals losing skills as unemployment duration is longer.” Worse still is the argument that since any loan modification will be based on lowering monthly housing expenses to 31% of gross pay, unemployed homeowners are disincentivized from getting new work in order to attempt to maximize any reduction in monthly payments by minimizing earnings. This results in an unemployed worker not only foregoing a job opportunity that may present itself, but also that the workers unused skills deteriorate over time, making re-employment even more difficult.
Although not specifically discussed in the article referenced above, and we make no claim to being economic experts, if the first two options for underwater homeowners (doing nothing and mortgage modification) cause people to stay put, thus reducing mobility and increasing unemployment, it seems logical that the converse may be true; specifically, if the homeowner chooses either of the latter two options (short sale or foreclosure), resulting in the homeowner leaving the home, many of these people will have the opportunity to find a new residence in a better job market and thus reducing unemployment. Furthermore, the buyers of these short sold or foreclosed homes will likely be buying new furniture and making improvements to the home, thus further helping economic growth.
Nagle Law Group’s experienced residential real estate team has been practicing real estate law for over 20 years. Robert Nagle and Stuart Pack are partners with Nagle Law Group, P.C., focusing on residential transactional and debt management matters, and can be reached at 602-595-3156 or firstname.lastname@example.org and email@example.com.