Quite apart from financial losses, the massive foreclosures of the past few years pose another, long-term problem for the mortgage industry: fewer potential borrowers.
More than 6 million homeowners were foreclosed on in the past three years, according to RealtyTrac Inc. The Irvine, Calif., data firm estimates that another 3 million are headed to foreclosure this year. Most of these people will be ineligible for new mortgages for as long as five years.
That's because in most cases a foreclosure in the last five years on the borrower's credit report would make any new loan ineligible for sale to Fannie Mae or Freddie Mac.
Using home sales as a gauge — about 5 million homes get sold in a given year — that means the equivalent of close to two years' worth of homebuyers has been effectively shut out of the housing market.
"Anybody who looks at the numbers realizes we've wiped out a whole tranche of homebuyers," said Rick Sharga, a senior vice president at RealtyTrac. "There is a lot of discussion about giving these defaulted homeowners what amounts to a mulligan."
A group of mortgage executives has been lobbying the government to do just that.
Their proposed "Second Chance" program, which has been generating buzz in industry circles for the last month or so, would allow a wide range of borrowers who lost their homes to be rehabilitated in just two years after undergoing credit counseling.
Eligible candidates would include homeowners who fell out of the Treasury Department's Home Affordable Modification Program and gave up their homes through a short sale or deed in lieu of foreclosure.
"We know a lot of these people can't keep their homes," said Rayman Mathoda, one of the plan's architects and the president and chief executive of AssetPlan USA, a Long Beach, Calif., firm that arranges short sales. "You can't squeeze water out of a rock," she said.
The plan aims "to help support the recovery of the housing market" by boosting demand for housing in the next two to three years, according to a 41-page proposal that Mathoda co-wrote with executives at Prospect Mortgage LLC, a lender in Sherman Oaks, Calif.
Under the plan, borrowers would receive credit counseling and other financial advice; credit-repair services; insurance against job losses; and assistance finding rental housing for the rehabilitation period.
The plan suggests several ways borrowers who completed the program could live down their recent past. One way is to give them a special credit score that does not take into account their recent default on a mortgage and looks only at their payment history since receiving counseling. Alternatively, Fannie, Freddie and the Federal Housing Administration could waive their usual restrictions on lending to defaulted borrowers for graduates of the program.
As it stands Fannie and Freddie require defaulted borrowers who go through a short sale — in which a home is sold for less than the mortgage amount and the lender accepts a discounted payoff — to wait two years before they can buy another home. When extenuating services behind a foreclosure can be documented, the government-sponsored enterprises require three years rather than five to re-establish credit.
The minimum wait period for the Federal Housing Administration is three years for a short sale, a deed-in-lieu or a foreclosure. (The FHA has one exception: Borrowers who were current on their mortgage and other debts and used the proceeds of a short sale to pay their mortgage in full can buy another home immediately afterward.)
"These people got a DUI on a mortgage," said Ron Bergum, the CEO of Prospect Mortgage and another co-author of the proposal. "This fills the gap between the person losing the house to becoming a renter and then, their hope to be a homeowner again."
He and Mathoda are both veterans of IndyMac Bank, a once-highflying lender that failed in 2008. Mathoda is also a city commissioner for the Los Angeles Public Housing Authority.
As one might guess, not all lenders think reducing the wait time for defaulted borrowers is a good idea. "Relaxing our standards is what put us all in this situation," said Lisa Schreiber, the chief strategy officer at NetMore America, a lender in Walla Walla, Wash. "It can't be at the risk of weakening the system again."
Sharga said it was ironic that mortgage lenders would advocate a program to allow foreclosed borrowers to get financing earlier than expected "when people that haven't gone through foreclosure are having trouble getting financing."
"It does come down to motivated self-interest on the part of the bankers," he said.
The Second Chance proposal even contemplates providing borrowers with down-payment assistance for a new home once they have been rehabilitated.
But according to the proposal, Second Chance would not cost the taxpayer anything. Instead, the program would be funded by what amounts to a tax on distressed real estate sales. Instead of collecting the customary 6%, real estate agents would get 4.5% for brokering the sale of a repossessed home. The other 1.5% of the sale price would go to pay for the program.
It remains to be seen how much traction the plan will gain. Fannie did not return a call seeking comment. Freddie, the Federal Housing Finance Agency (the GSEs' conservator) and the Department of Housing and Urban Development (which oversees the FHA) all declined to comment.
Lenders and observers differ on how long a borrower should sit in rehab. One indication is how quickly a borrower's credit score rebounds. Barrett Burns, the CEO of VantageScore Solutions, a Greenwich, Conn., firm that sells an alternative to FICO scores, said it can take borrowers as little as nine months to repair their credit score after a short sale or foreclosure.
A two-year wait before the borrower can buy another home "makes sense," he said. Regulators, however, may be "pretty skeptical" about letting borrowers who got overextended back in. "We have to be careful about this, because you could attract people who are going to game you again," Burns said.
Another concern is determining which borrowers should get a break. Many borrowers who can pay but chose not to could manipulate the system. "Lenders want to help the person negatively impacted by factors beyond their control, but not those who bet against the ranch for a quick dollar," said Scott Slifer, a senior vice president of business and marketing at Altisource Portfolio Solutions Inc., a Kennesaw, Ga., default management and technology provider.