Not long ago, economists and housing market experts worried about there being too many foreclosures. Now they’re worried foreclosures aren’t proceeding fast enough, thanks to the robo-signing fiasco that prompted a moratorium on foreclosure proceedings at many major banks.
If you’re up to date on your mortgage payments and just watching from the sidelines, the foreclosure mess may look like something that only matters to other people. True, a lot of foreclosed properties dumped on the market at fire sale prices can push down home prices. But housing markets are localized, and high foreclosure rates are concentrated in some previously inflated markets, so why worry about foreclosures if your neighborhood is doing OK?
Well, unfortunately, one of the byproducts of the foreclosure mess is the nationwide damage it may create to the perception that homes make good collateral. That perception could cause lenders to hang on to the tight lending policies they adopted in the recession, and perhaps keep interest rates higher than they’d be otherwise.
An analysis by Jack Guttentag, emeritus professor of finance at the University of Pennsylvania’s Wharton business school, starts with a look at just how beneficial collateral can be.Guttentag says he recently shopped for two loans. On the first, a personal loan with no collateral, lenders offered up to $25,000 for three years at rates ranging from 8% to 17%. But for a mortgage application that used his home as collateral he was offered up to $400,000 at 4% for 30 years. It’s a dramatic difference considering that he reported the same income and credit score to qualify for each type of loan.
Obviously, collateral is valuable because it gives the lender something that can be sold to cover losses if the borrower stops making payments. A key factor is the ease with which the asset could be converted to cash. For lenders, the ideal collateral would be something like gold or short-term government bonds that could be sold with a few clicks of a mouse. A home is not quite as good because of the time and expense involved in wrangling it from the borrower and selling it.