How Will Foreclosures Affect Home Prices?

Three months ago, it was revealed that many banks were guilty of improperly processing the paperwork on their foreclosures. Most banks at the time declared a foreclosure moratorium while they reviewed their paperwork and corrected any errors. Today, we want to give you an update on the situation and explain how the housing market will be affected.

The banks have admitted to some procedural errors. The severity and intent of these errors is still being investigated and the proper sanctions are being debated (one state attorney general is threatening jail time). However, there seems to be no evidence that families were incorrectly forced from their homes.

So what does mean to the housing market?

When this discounted inventory enters the market, it will put downward pressure on house values. Foreclosures entering the market put downward pressure on the non-distressed properties trying to sell. A foreclosure is competition to other homes as they sell for a 41% discount.

When will this inventory come to market?

Celia Chen of Moody’s Analytics on when this inventory is expected to hit the market:

The “robo-signing” scandal is beginning to show up in U.S. foreclosure data. The inventory of homes in foreclosure rose sharply in the fall, reflecting the fact that a number of large mortgage servicers placed a moratorium on foreclosures midway through October, and were thus unable to complete these foreclosures and reduce inventories. Servicers have already lifted some of these moratoriums and it is likely business will return to usual by the beginning of 2011.

…sales of REOs to third parties and other types of distress sales such as short sale or auction sale to a third party will step up in the first quarter of next year as servicers resolve the foreclosure processing issues.

What impact will it have on house prices?

Prices will be affected. The question is to what degree. Ms. Chen explains it simply:

…the larger the ratio of distress sales to normal, nondistress sales, the greater the downward pressure on prices.

How many distressed sales are out there? According to Daren Blomquist, managing editor of the RealtyTrac:

“Even with this big drop in November we do have a continuing building inventory of properties in foreclosure or REO. We’re estimating those properties plus delinquencies to equal 3 million to 4 million homes waiting to hit the market.”

Bottom Line

With the enormity of the challenge, prices can be impacted in a big way. Ms. Chen in her report said she sees a 5% decline in prices through the first three quarters of 2011.

Reprinted from KCM Blog by permission