Document Type

Article

Publication Date

January 2014

Abstract

From 2007 through 2011, the United States housing market suffered a severe imbalance in supply and demand due to an excessive number both of foreclosed homes and homes awaiting foreclosure in the shadow housing inventory. Foreclosure prevention can help reduce the shadow housing inventory by keeping troubled mortgages from entering that inventory to begin with. The loan modification experience post-2008 yielded four main lessons about the best way to optimize foreclosure prevention. First, servicers should design loan modifications to lower monthly payments, including through principal reduction whenever appropriate. Second, servicers should evaluate loss mitigation as soon as possible following delinquency. Third, when distressed borrowers lack the cash flow for cost-effective loan modifications, servicers should explore other ways to keep those homes occupied, such as short sales, in order to avoid unnecessary spillover effects to the surrounding community. Finally, subsidies are not enough alone to overcome the frictions to an optimal number of loan modifications. The paper closes by discussing the implications for policy reform.

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