There is no doubt the foreclosure problem is getting worse; we haven't seen the bottom yet.  CNNMoney.com is reporting that foreclosure filings in the second quarter of this year are up 120% over the same period last year!  One of every 171 households received a notice of default, auction sale notice, or bank repossession notice.  The second quarter was so bad that RealtyTrac will have to "reevaluate its foreclosure forecast" for the year.  According to RealtyTrac CEO, James Saccadic, they had been predicting 1.9 million to 2 million foreclosures for 2008.   "But midway through the year, we're already at 1.4 million," he said.

And, there is more bad news.  Bank repossessions are up as a proportion of total filings, representing 30% of the notices issued during the second quarter, up from 24% a year ago.  But, the numbers do not show how truly awful things are.  There is something else that the numbers aren't telling us... something that makes that whole foreclosure epidemic even worse that it seems.

All of this data comes from RealtyTrac.

Founded in 1996, RealtyTrac publishes the largest and most comprehensive national database of pre-foreclosure, foreclosure, For Sale By Owner, resale and new homes, with more than 1 million properties across the country, property reports, productivity tools and extensive professional resources.

RealtyTrac does an excellent job of aggregating and analyzing the data.  However, if you look closely at the methodology they use to compile the statistics... there is something missing.

Report methodology
The RealtyTrac Monthly U.S. Foreclosure Market Report provides a count of the total number of properties with at least one foreclosure filing reported during the quarter — broken out by type of filing at the state and national level. Data is also available at the individual county level. RealtyTrac’s report incorporates documents filed in all three phases of foreclosure: Default — Notice of Default (NOD) and Lis Pendens (LIS); Auction — Notice of Trustee Sale and Notice of Foreclosure Sale (NTS and NFS); and Real Estate Owned, or REO properties (that have been foreclosed on and repurchased by a bank). If more than one foreclosure document is filed against a property during the quarter only the most recent filing is counted in the report. The report also checks if the same type of document was filed against a property in a previous quarter. If so, and if that previous filing occurred within the estimated foreclosure timeframe for the state the property is in, the report does not count the property in the current month.

This certainly seem like a very comprehensive system that takes full advantage of the available information.  However, there are other transactions, equally devastating, that are not reflected by the foreclosure filings... deeds in lieu of foreclosure and cancelled mortgages - those that should go into foreclosure, but... the bank doesn't want the property back.

I have seen many more of these types of transactions lately.  I have even talked to a few people who have been negotiating with their lender to try to get out from under over-burdening mortgage payments.

"I have already talk to the bank," said one homeowner.  "They have agreed to take back my home in lieu of foreclosure.  I just can't afford it anymore."

Lenders often prefer to take the home back in this manner because they can avoid a lot of the expense involved in foreclosure.  They are able to get the property back sooner and, hopefully, sell it to get the debt off their books.  This more efficient process can help the banks bottom line.  Take First Place Financial, for example:

First Place works with borrowers to avoid foreclosure if at all possible. Furthermore, if it becomes inevitable that a borrower will not be able to retain ownership of their property, First Place often seeks a deed in lieu of foreclosure in order to gain control of the property earlier in the recovery process. First Place has been very successful in obtaining deeds in lieu of foreclosure in the current quarter. As a result, the balance of real estate owned grew 79.3% during the current quarter while nonperforming loans have declined 11.8%. Over the long term, this should result in a significant reduction in the holding period for nonperforming assets and reduce economic losses.

The effect of foreclosure and deed in lieu are roughly the same in terms of what it does to the homeowner and our economy.  In both, the homeowner loses the home and it goes into the lender's REO (Real Estate Owned) inventory.   Though the deed in lieu may be quicker, and perhaps less emotionally draining on the homeowner, it still has a serious impact on the borrower's credit score.

"The FICO scoring algorithm regards foreclosed and deed-in-lieu accounts as serious derogatories," said Craig Watts, spokesman for Fair Isaac Corp., which created the FICO credit score. "And a serious derogatory is the single worst thing a person can do to her FICO score."

This can even impact the borrower's ability to rent a home, as Forbes.com reported in Foreclosure Stigma Haunts Would-be Renters.

As foreclosures rise across the country and skyrocket in economically depressed areas and once-hot housing markets, more apartment owners are seeing an increase in the number of rental applicants with blemished mortgage histories. That includes foreclosures, short sales - when a house is sold for less than the amount owed on the mortgage - and deed-in-lieu of foreclosure, when a homeowner gives up a house to the lender to end the foreclosure process.

One Virginia couple ended up living in a hotel after their foreclosure, according to Trish Lynch, a trainer and former credit counselor at ClearPoint Financial Solutions, who worked with them.

"No one would rent to them. And the hotel is costing them $3,000 a month to stay there," she said.

Lynch recommended they try to rent from a private owner or individual who might be more lenient on credit checks, but who could also ask for higher rents to cover their risk. So far, the couple's still stuck at the hotel.

Renters who found that their credit was at least good enough to purchase a home are now returning to the rental market with serious credit problems.  Owners of rental property still need to be assured that they will be able to collect their rents; and, one of their tools is a credit check on would-be tenants.  Some landlords may refuse to rent to those with a poor credit history, others may require extra security deposits.  Renting has become much more risky for the landlord which means higher rent for those in need of housing... if they can find a landlord willing to rent to them.

And what about the other category I mentioned?  I have seen several properties that appear to be headed into foreclosure that the banks just don't want to take back.  These have typically been run-down rental units in desperate need of repairs. The banks know that they will have a very tough time trying to sell them and they could wind up with fines from the city for failing to maintain them.  Or worse yet, face a condemnation order.  So, rather than foreclose, or take them back by deed in lieu, the lender simply releases the mortgage and writes the loan off.  Most of these homes are not worth much and the debt on each is rather low, but they are often one of many homes secured by a larger loan. 

What effect does this have?  The homes are usually already in a blighted area but since the owner could not afford the payments, he likely cannot afford the upkeep on the homes either.  This causes a further deterioration of inner-city neighborhoods which drags down the value of surrounding properties.  This adds further to the problem of people owing more than their home worth, which has a domino effect on foreclosures.

So, as bad as the foreclosure outlook is, it is only a part of the big picture.  The tragic problem is worse than the numbers show.  And, I still don't think that we have seen the bottom yet.  Foreclosure filings, and alternatives like deeds in lieu, will continue to become more grim through the end of this year.  Congress has a "housing rescue plan" that they expect to implement in October, but how much it will really help remains to be seen.  It may be too little, too late.  Millions of homeowners have already suffered the consequences of losing their homes and have had their credit score marred - millions more are teetering on the edge. 

Easy access to credit has spurred our economy for the past couple of decades.  With so many people unable to continue to "borrow and spend," whether on credit cards or a home equity line of credit, our economy will feel the pinch.  Without a strong economy, the housing market will continue to suffer.  We are beyond a "mortgage bailout," we need an expansive economic recovery act.  I don't mean a $600 tax refund - we need to rebuild our economy to provide good jobs and security to our citizens.  A housing rescue plan is merely a band-aid.

Robert A. Franco
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