Janneke Ratcliffe

Preventive servicing is good for business and affordable homeownership policy

Abstract This article documents the growing importance of preventive servicing—business practices that emphasize early intervention in delinquency and default management practices that also help financially troubled borrowers avoid foreclosure. We suggest that the loan servicing side of the affordable housing delivery system may be underappreciated and undercapitalized. We use a database of more than 28,000 affordable housing loans to test several preventive servicing‐related propositions and find that after we control for loan and borrower characteristics, the likelihood that a delinquent mortgagor within this universe will ultimately default varies significantly across servicers. This suggests that loan servicing is an important factor in determining whether low‐ and moderate‐income borrowers who fall behind in their mortgage payments will end up losing their homes through foreclosure. It also suggests a need for policy makers to incorporate preventive servicing into affordable homeownership programs.

The preventable foreclosure crisis

As of this writing, some 5 million households are in default or some stage of foreclosure,1 and the U.S. financial system, once the envy of the world, seems to be falling apart. What went wrong? Everyone seems to have a favorite suspect. Some blame borrowers who bet that house prices would always go up and overextended themselves. Others blame lenders or other participants in the home sale and origination process (brokers, real estate agents, appraisers, builders) for focusing on short-term profits without considering borrowers’ ability to pay. Some blame Wall Street for recklessly going about the business of securitization. Others blame investors for lack of due diligence when purchasing private securities and derivatives or the credit rating agencies that evaluated investments backed by risky mortgages or the companies that insured these investments. Still others blame the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac. Finally, some have accused former Federal Reserve Chairman Alan Greenspan of being the chief enabler of the crisis. Concerned with the risk of deflation in 2003, the Federal Reserve reduced a key interest rate to 1 percent and kept it there for a year, thus encouraging overleveraging in all aspects of the market.

Setting the Record Straight on Affordable Homeownership

In his 1991 groundbreaking work Assets and the Poor: A New American Welfare Policy, Michael Sherraden permanently shifted the discussion about welfare policy in the United States. Sherraden argued for a focus on the promotion of savings and wealth generation rather than the then-current emphasis on income and consumption. He advanced the use of Individual Development Accounts (IDAs) in order to push welfare policy beyond addressing immediate needs and instead to the support of long-term economic well-being for lower-income households. Sherraden’s groundbreaking work argued that low-resource households can build financial security if given access to the proper tools and systems.