The Principal Principle: Optimal Modification of Distressed Home Loans
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Why Lenders should Forgive, not Forsake Mortgages ...
Why Lenders should Forgive, not Forsake Mortgages
The current housing crisis has resulted in several homeowners defaulting on their mortgages. Foreclosure lings numbered 321,480 during May 2009 (approximately 1 of every 400 homes), up 18% from the previous year. 2 When dealing with failing borrowers, lenders need to decide between modifying the loan or foreclosing. Modification results in a lowering of the present value of
the loan. Foreclosing incurs deadweight costs that reduce the recovery value of the home. This paper develops a framework for reducing foreclosure losses by loan modification, and how best to implement it. Foote, Gerardi, Goette and
Willen (2009) estimate that loan modification versus premature foreclosure will save $180 billion, or 1% of GDP a year.
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