Federal Reserve Study Finds Foreclosure Laws Costly To Borrowers

(Wednesday, September 03, 2003) - Economist Karen Pence has recently published the results of her study for the Federal Reserve System on "defaulter-friendly" state foreclosure laws. The study concluded that such laws add on to the borrowers' costs at the time of origination.

During the study, which used nearby census tracts that were in different states, Pence discovered that loan sizes in states where foreclosure laws are stricter in their protection of borrowers tended to be 4% to 6% lower. This led her to believe that these laws add costs to borrower during loan origination.

Pence's study also revealed losses on foreclosures tend to fall between 30% and 60% of the outstanding balance, due to the fact that property expenses, legal fees and foregone interest are, more often than not, higher than the income gained from repossessing and selling the property. Of course, these losses tend to be more severe in states with strict foreclosure laws. The study noted that borrowers in states with higher foreclosure losses often absorbed higher origination costs.

Pence also concluded that, in general, the longer the foreclosure process, the higher the lender costs.

"If lenders pass the higher associated costs onto borrowers, the laws may have the unintended consequence of reducing the supply of mortgage credit," Pence wrote.

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