Who Pays for a Foreclosure Freeze? We the Taxpayers Do

Who do you think picks up the losses on the $500 billion worth of mortgages now in foreclosure or in serious default? The wicked lenders? Sorry, wrong. In more than half the cases, we the taxpayers do.

Freezes on foreclosures, such as those in effect in at least a quarter of the states, are providing many troubled homeowners with a little more breathing space. They've been victims of sloppy or fraudulent paperwork that puts court proceedings in doubt. On the other hand, they haven't paid what they owe and most of them probably won't be able to. The longer their loans are in default, the larger the taxpayer cost. Here's why:

More than half the mortgages in the country are insured by four government-controlled entities: Fannie Mae, Freddie Mac, the Federal Housing Administration (FHA), and the Department of Veterans Affairs (VA). Most of these loans are bundled into securities and sold to investors. The government guarantees that they'll receive all their interest and principal payments on time.

When a homeowner skips a payment, the mortgage servicer advances the payment from its own funds. Then it bills the government guarantor for the expense, plus fees. After a certain number of months, the servicer forecloses, gives the investors their money back and passes that cost to the government, too. Fannie and Freddie have been forced to purchase roughly $200 billion in defaulted loans this year alone.

The average homeowner in default hasn't made a payment in more than a year, according to LPL Applied Analytics, yet is still living in the house. The longer the family can put off eviction, the better for them and the worse for the taxpayer, who is picking up the bill.

When homes are finally foreclosed, the guarantors also have to cover the maintenance costs and property taxes, including back taxes, until a buyer is found. People who haven't paid their mortgage have probably skipped their taxes, too.

Don't get me wrong. I am deeply sorry for homebuyers who were misled by the subprime lender cheats or who bought an affordable home, in good faith, and have since lost their jobs. It's a tragedy. But if they can't make their payments any more, they need to move on. No magic will bring their old home values back.

I'm angry at the cruel system that evicts working people who could afford their homes if they were allowed to refinance at today's low interest rates. The lenders slammed the door on them because they don't meet the stiffer underwriting standards imposed since 2009. Those homes are being lost unnecessarily. Rescuing them would have been a good use of the unspent TARP money used to bail out banks, but that's not going to happen now. Not many candidates in this election are promising homeowners a break.

I feel the frustration of homeowners who could have qualified for a loan modification but were strung along by callous mortgage servicers, who collected as many payments as possible and then foreclosed.

But now what? Even if you win a loan mod, it might not save you. More than half of the people with modifications redefault in the first year. Their new payments are still too high or they decide that the effort isn't worth it. Those lucky enough to get their loan principal reduced aren't home free, either. In most cases, that principal has to be repaid at some future date -- usually as a balloon payment. Will the borrowers be able to afford that expense when it hits?

For all the sorrow eviction causes, people who can't afford their mortgages are going to be washed out. The longer it takes, the higher the taxpayer cost.

Not all the losses are born by the government. Investors take the hit on mortgage securities that don't carry guarantees. These investors might be banks. They might also be state and city pension funds or fixed-income mutual funds.

One set of investors is safe, however -- those who buy Ginnie Mae securities or mutual funds. Most of the mortgages in these pools are guaranteed by the VA or FHA. When they default, the government makes up the loss.

Ginnie Mae investors might even gain a little from the foreclosure freeze, says Ron Reardon, a specialist in mortgage backed securities for the Vanguard group of funds. The older mortgage loans that are being kept alive carry higher interest rates than the ones available today. When they're finally foreclosed and the principal is repaid, the fund managers have to reinvest at lower rates. So delay works in the investors' favor, even though taxpayers are harmed.

Delay also benefits the higher-interest, non-insured investment pools that hold a lot of second mortgages, says Andy McCormick, head of securitized products for the mutual fund group, T. Rowe Price. When payments aren't guaranteed, investors in first mortgages want to foreclose fast, to get more of their money out. But foreclosures usually wipe out the seconds, so delay suits them fine.

Many homeowners keep making payments on their second mortgages (generally, home-equity loans) even when they're in default on their firsts. That makes no sense -- but second lienholders will work to keep these loans on the books for as long as they can.

More on MoneyWatch:
Special Report: Foreclosure Fiasco
Mortgage Tip: Sometimes It's Smarter Not to Pay, Even if You Can Afford It
Foreclosure Mills: How This Could Really Hurt the Housing Market
Are You Paying Too Much for Financial Planning and Advice?
Bank Overdraft "Services": How They Still Cheat You