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Housing Policy Council
1001 Pennsylvania Avenue NW
Suite 500 South
Washington DC 20004
(202) 289-4322

1325 G Street NW
Suite 800
Washington, DC 20005
(202) 220-2300

The recent rise in nonprime mortgage foreclosures has opened a new and costly
chapter in many of the nation’s most distressed urban neighborhoods. Particularly
problematic is the fact that today’s foreclosures impose significant costs not only on
borrowers and lenders, but also on municipal governments, neighboring homeowners
and others with a financial interest in nearby properties. While there is an extensive
literature on the impact that delinquency, default, and foreclosure have on lenders,
borrowers, and other entities that are direct parties to the mortgage transaction in
question, the costs that these mortgage failures impose on municipalities and other third
parties are far less well understood. This is due to two factors. First, municipal and other
third party costs are difficult to identify, and therefore often go undetected. Second,
even where identified, the activities that generate costs often blend in with other
governmental functions, or are otherwise difficult to quantify, reinforcing the tendency
for them to remain invisible.

This study attempts to fill that void. Using the City of Chicago as a case in point, this
study presents a conceptual framework that makes explicit the various costs of
foreclosure, especially as they relate to local governments and courts. By carefully
reviewing the foreclosure process as it plays out in Chicago, the paper isolates 26
separate costs incurred for the provision of ‘foreclosure related services.’ These costs
reflect actions undertaken by 15 separate governmental units that are part of the overall
municipal infrastructure underlying the foreclosure process. While in some cases these
municipal activities are limited to simple and relatively inexpensive ministerial duties of
agencies like the Recorder of Deeds, in more complex foreclosure scenarios these
municipal costs can reach tens of thousands of dollars. In extreme cases, the
concentrated foreclosures can put downward pressure on area property values and
indirectly rob area homeowners of hundreds of thousands of dollars of home equity.

Foreclosures, especially in the nonprime mortgage market, have been on the rise for
over a decade. While mortgages of all types may end up in foreclosure, the rate of
serious delinquencies and foreclosures for nonprime loans can easily be ten times
higher than the rate for prime loans due to a number of factors, most obviously the
generally lower credit quality of the borrowers. Moreover, the focus on credit impaired
and higher risk borrowers leads to a natural tendency for nonprime foreclosures to
cluster in lower-income and largely minority distressed urban areas.

This tendency for nonprime foreclosures to cluster generates significant negative
spillover effects. Since many foreclosed properties become vacant and abandoned,
they act as magnets for crime, violence, and other social ills. The foreclosure situation
facing property owners on a single block in the Auburn/Gresham neighborhood of
Chicago is illustrative. Over the past decade, the block’s 37 properties experienced 14
separate foreclosures, with several homes going through the foreclosure process
multiple times. Accounting for both the foreclosure costs paid for by City and County
agencies, and the impact of foreclosures on area property values, a foreclosure on this
block could impose direct costs on local government agencies totaling more than
$34,000 and indirect effects on nearby property owners (in the form of reduced property
values and home equity) of as much as an additional $220,000.

Foreclosure related costs of this magnitude raise a number of policy concerns. At the
core of these concerns are questions about how best to reduce the financial burden
foreclosures impose on neighbors and municipalities, and how best to pay for the
unavoidable costs that do arise. The fact that municipalities and residents living near the
foreclosed property currently bear a significant portion of foreclosure related costs is
certainly an unintended consequence of efforts to attract mortgage capital to previously
underserved inner-city areas. The result, however, is that local taxpayers and area
residents are forced to shoulder burdens that are rightfully the responsibility of
borrowers, mortgage lenders and others that are direct parties to the mortgage
transaction. The failure of borrowers and lenders to pay the full social costs of nonprime
lending also leads to perverse market effects, as less than scrupulous lending
organizations overextend credit to highly foreclosure prone borrowers.

The extension of mortgage lending to higher risk borrowers has benefited millions. At
the same time, risk-based pricing only efficiently allocates mortgage credit if all the
expected risks and costs are reflected in the pricing of the deal. In the many instances
in today’s market where nonprime loans are likely to lead to concentrated foreclosures
that produce significant negative external effects, this is simply not the case. Absent
greater efforts to identify those costs that properly should be paid by some combination