Homeowners that go through a foreclosure are likely to have elevated delinquency rates on other types of consumer credit for many years to come, an effect that has implications for loan modifications, according to a new study from the Federal Reserve.
Borrowers entering foreclosure see a rapid reduction in their credit scores to subprime levels, which reduces access to credit and increases costs. And these borrowers "exhibit substantially worst payment performance in the years that follow," the Fed says.
"These post-foreclosure effects are particularly pronounced for borrowers who had prime-quality credit scores prior to their mortgage delinquency," writes Federal Reserve economists Kenneth Brevoort and Cheryl Cooper.
The authors point out that this change in payment behavior could be linked to high re-default rates on loan modifications.
Most loans modifications are initiated after the borrower is seriously delinquent. "As a result, the damage to the credit scores of the borrowers is already done and, to the extent that this contributes to the persistence of the post-foreclosures effect that we observe, modification may not alleviate these effects," the authors say.
Many servicers also begin processing borrowers for a foreclosure even while they engage in a loan modification for the same customer. According to consumer advocates and critics, this practice, known as "dual-tracking," confuses borrowers and the mortgagor ends up receiving foreclosure notices while they are current on their modified payments.
The Fed study -- "Foreclosure's Wake: The credit Experience of Individuals Following Foreclosure" -- also shows that borrowers entering foreclosure after 2006 have "notably higher" post-foreclosure delinquency rates than the historical experience.
