Determinants of Mortgage Default and Consumer Credit Use: The Effects of Foreclosure Laws and Foreclosure Delays

The mortgage default decision is part of a complex household credit management problem. We examine how factors affecting mortgage default spill over to other credit markets. As home equity turns negative, homeowners default on mortgages and home equity lines of credit at higher rates, whereas they prioritize repaying credit cards and auto loans. Larger unused credit card limits intensify the preservation of credit cards over housing debt. Although mortgage nonrecourse statutes increase default on all types of housing debt, they reduce credit card defaults. Foreclosure delays increase default rates for housing and nonhousing debts. Our analysis highlights the interconnectedness of debt repayment decisions.     

Characteristics of Mortgage Terminations: an Analysis of a Loan-Level Dataset

Understanding mortgage termination behavior is crucial for valuating mortgage-backed securities. Analyzing a unique loan-level dataset, this study examines the characteristics of mortgage prepayment and default behaviors in the Korean housing and housing finance markets. We also analyze mortgage termination behaviors across regions, loan purposes, and periods. The results suggest that the prepayment rate of fixed-rate mortgages (FRMs) and the ratio of adjustable-rate mortgages to FRMs can provide meaningful signals for the Korean household economy. Although the macro-prudential policies pertaining to the loan-to-value ratio (LTV) and debt-to-income ratio (DTI) are very effective, their effects can vary depending on the region or loan purpose. Furthermore, the DTI and credit score cannot always identify the default risks of mortgages not intended for housing purchases even though such mortgages are more vulnerable to macroeconomic changes. The observed changes in default behavior indicate that the government’s policies to promote fixed-rate loans have achieved a certain degree of success.     

Loss given default of residential mortgages in a low LTV regime: Role of foreclosure auction process and housing market cycles

Using loan-level foreclosure auction data we study the loss given default (LGD) of defaulted residential mortgages originated in Korea, a low LTV regime. We find that senior mortgages generate very low loss rates (5–10%) while losses of subordinated claims are in 30–50% range. We document the effects of housing market cycles on loss severity by showing that collateral characteristics that are overvalued during the boom increase loss severity during the market downturn. We also investigate how a broad set of time-of-origination and post-origination information on loan, collateral and borrower characteristics and foreclosure auction process influence the LGD of residential mortgages.     

Subprime Loan Default Resolutions: Do They Vary Across Mortgage Products and Borrower Demographic Groups?

This paper examines default outcomes for subprime first lien loans during the recent subprime mortgage boom. It conducts this investigation in two phases. The paper first examines factors associated with pre-foreclosure outcomes for subprime mortgages in default. It then examines factors associated with different outcomes for loans that enter foreclosure. These factors include less understood elements such as mortgage product features and borrower demographics. The analysis is based on detailed loan-level data and employs multinomial logit models in a hazard framework. Results show that default resolutions vary with product features and borrower demographics. Adjustable rate and interest-only mortgages, and loans with low- or no-documentation are more likely to enter foreclosure proceedings, and, once in foreclosure, are more likely to become REO. The existence of junior liens increases the probability of the loan remaining in default. Owner-occupancy is associated with lower likelihood of foreclosure initiation and REO, and greater likelihood of curing default. Additionally, default outcomes are impacted by local legal, economic and housing market conditions, and the equity in the home.     

Credit History and the Performance of Prime and Nonprime Mortgages

Although nonprime lending has experienced steady or even explosive growth over the last decade very little is known about the performance characteristics of these mortgages. Using data from national secondary market institutions, this paper estimates a competing risks proportional hazard model, which includes unobserved heterogeneity. The analysis examines the performance of 30-year fixed rate owner occupied home purchase mortgages from February 1995 to the end of 1999 and compares nonprime and prime loan default and prepayment behavior. Nonprime loans are identified by mortgage interest rates that are substantially higher than the prevailing prime rate. Results indicate that nonprime mortgages differ significantly from prime mortgages: they have different risk characteristics at origination; they default at elevated levels; and they respond differently to the incentives to prepay and default. For instance, nonprime mortgages are less responsive to how much the option to call the mortgage or refinance is in the money and this effect is magnified for mortgages with low credit scores. Tests also reveal that default rates are less responsive to homeowner equity when credit scores are included in the specification.     

Strategic loan modification: An options-based response to strategic default

This paper presents a parsimonious barrier model for the optimal principal reset in a loan modification, thereby maximizing the loan value to the lender bank and minimizing the likelihood of strategic foreclosure by the homeowner. Writing down the loan-to-value (LTV) ratio will reduce the present value of future payments on the loan, but will also reduce the probability of default, thereby saving foreclosure losses. The optimal trade-off of these two countervailing effects will pinpoint the optimal LTV at which the loan must be reset. We present a simple barrier option decomposition of the loan value that makes the optimization of LTV easy to implement. An extension of the model is shown to account for varying growth rate assumptions about house prices. The model in this paper specifically accounts for the homeowner’s willingness to pay, and uses the framework to model shared-appreciation mortgages (SAMs).     

House‐Price Expectations,Alternative Mortgage Products,and Default

The goal of this paper is to better understand the forces that spurred use of alternative mortgages during the housing boom. A theoretical model shows that, when future house‐price expectations become more favorable, reducing default concerns, mortgage choices shift toward alternative products, which are characterized by backloading of payments. The empirical work confirms this prediction by showing that an increase in past house‐price appreciation, which captures more favorable expectations for the future, raises the market share of alternative mortgages. In addition, the paper tests the fundamental presumption that backloaded mortgages are more likely to default, finding support for this view.     

Mortgage Design in an Equilibrium Model of the Housing Market

How can mortgages be redesigned to reduce macrovolatility and default? We address this question using a quantitative equilibrium life‐cycle model. Designs with countercyclical payments outperform fixed payments. Among those, designs that front‐load payment reductions in recessions outperform those that spread relief over the full term. Front‐loading alleviates liquidity constraints when they bind most, reducing default and stimulating housing demand. To illustrate, a fixed‐rate mortgage (FRM) with an option to convert to adjustable‐rate mortgage, which front‐loads payment reductions relative to an FRM with an option to refinance underwater, reduces price and consumption declines six times as much and default three times as much.     

Asset Quality Misrepresentation by Financial Intermediaries: Evidence from the RMBS Market

We document that contractual disclosures by intermediaries during the sale of mortgages contained false information about the borrower's housing equity in 7–14% of loans. The rate of misrepresented loan default was 70% higher than for similar loans. These misrepresentations likely occurred late in the intermediation and exist among securities sold by all reputable intermediaries. Investors—including large institutions—holding securities with misrepresented collateral suffered severe losses due to loan defaults, price declines, and ratings downgrades. Pools with misrepresentations were not issued at a discount. Misrepresentation on another easy‐to‐quantify dimension shows that these effects are a conservative lower bound.     

Termination of distressed residential mortgages: An empirical analysis

A sample of 209 distressed mortgages is used to analyze the terminations of distressed mortgages. An option-based model is compared to a traditional default model. Results show that the traditional model is statistically superior. However, the model's ability to identify a default is similar to that of the simpler option-based model. Alternative measures of borrower's equity are compared. Measuring borrower's equity using total debt more accurately explains default than using either the mortgage balance or the mortgage value.     

An agent-based model for the assessment of LTV caps

We assess the effects of regulatory caps in the loan-to-value (LTV) ratio for housing mortgages using an agent-based model. Sellers, buyers and banks interact within a computational framework that enables the application of LTV caps to a one-step housing market. We first conduct a simulation exercise; later, we calibrate the probability distributions based on actual European data from the Household Finance and Consumption Survey. In both cases, the application of an LTV cap results in a modified distribution of buyers in terms of property values, bidding prices and properties sold, depending on the probability distributions of the LTV ratio, wealth and debt-to-income ratios considered. The results are of similar magnitude to other studies in the literature embodying other analytical approaches, and they suggest that our methodology can potentially be used to gauge the impact of common macroprudential measures.     

The Allocation of Capital Between Residential and Nonresidential Uses: Taxes,Inflation and Capital Market Constraints

We have constructed a simple two-sector model of the demand for housing and corporate capital. Economic growth and an increase in the inflation rate were then simulated with a number of model variants. The model and simulation experiments illustrate both the tax bias in favor of housing and the manner in which the increase in inflation between 1965 and 1978 magnified it. The existence of capital-market constraints offsets the bias against corporate capital, but it introduces a sharp, inefficient reallocation of housing from less wealthy, constrained households to wealthy households who do not have gains on mortgages and are not financially constrained.     

Two Extensive Margins of Credit and Loan‐to‐Value Policies

We analyze a model of mortgage markets, housing tenure choice, heterogeneous agents, and default with closed form solutions. We uncover new insights which may inspire empirical work, and we ground already established insights in a series of tractable expressions. Then we study optimal loan‐to‐value (LTV) regulation and show that the choice of an LTV cap should balance the opposing forces of access to homeownership and the negative externalities associated with default. Homeownership affordability concerns induce procyclical elements into optimal regulation which attenuate the countercyclical regulation justified by the negative default externalities.     

Effects of Bankruptcy Exemptions and Foreclosure Laws on Mortgage Default and Foreclosure Rates

This study analyzes the effects of state bankruptcy asset exemptions and foreclosure laws on mortgage default and foreclosure rates across different segments of the mortgage market. We found that the effects of these legal provisions are larger for subprime than for prime mortgages and larger for adjustable rate mortgages than for fixed rate mortgages. These results demonstrate that the effect of variation in bankruptcy exemptions and foreclosure laws is most pronounced in the most risky segments of the mortgage market, which are those that have been most affected by the continuing housing slump in the United States.     

Breakeven Determination of Loan Limits for Reverse Mortgages under Information Asymmetry

Since the loan limit of a reverse mortgage is a major concern for the borrower as well as the lender, this paper attempts to develop an option-based model to evaluate the loan limits of reverse mortgages. Our model can identify several crucial determinants for reverse mortgage loan limits, such as initial housing price, expected housing price growth, house price volatility, mortality distribution, and interest rates. We also pay special attention to the important implication of mortgage lenders’ informational advantage over reverse mortgage borrowers concerning housing market risk. In reverse mortgage markets, the elderly borrowers typically hold far less, relative to the lenders, or no information about the lenders’ underlying mortgage pools. Such information asymmetry leads these two categories of market participants to generate different perspectives on the risk of the collateralized properties, which can be identified to be important in determining the maximum loan amounts of reverse mortgages. We further find that the maximum loan amount of a reverse mortgage decreases in the correlation between the returns on the pooled underlying housing properties but increases with the number of the pooled mortgages.     

A Dynamic Analysis of Fixed- and Adjustable-Rate Mortgage Terminations

This paper provides a side-by-side comparison of loan-level statistical models for fixed- and adjustable-rate mortgages. Multinomial logit models for quarterly conditional probabilities of default and prepayment are estimated. We find that the estimated impacts of embedded option values for prepayment and default are generally quite similar across both FRM and ARM loans, providing additional empirical support for the basic predictions of the options theory. We also find that differences in estimates of conditional probabilities of prepayment and default associated with mortgage age, origination period, original LTV, and relative loan size, indicate the continued significance of these other economic and demographic factors for empirical models of mortgage terminations.     

Housing,mortgage bailout guarantees and the macro economy

What are the macroeconomic and distributional effects of government bailout guarantees for Government Sponsored Enterprises (e.g., Fannie Mae)? A model with heterogeneous, infinitely lived households and competitive housing and mortgage markets is constructed to evaluate this question. Households can default on their mortgages via foreclosure. The bailout guarantee is a tax-financed mortgage interest rate subsidy. Eliminating this subsidy leads to a large decline in mortgage origination and increases aggregate welfare by 0.5% in consumption equivalent variation, but has little effect on foreclosure rates and housing investment. The interest rate subsidy is a regressive policy: it hurts low-income and low-asset households.     

A Model of Mortgage Default

In this paper, we solve a dynamic model of households' mortgage decisions incorporating labor income, house price, inflation, and interest rate risk. Using a zero‐profit condition for mortgage lenders, we solve for equilibrium mortgage rates given borrower characteristics and optimal decisions. The model quantifies the effects of adjustable versus fixed mortgage rates, loan‐to‐value ratios, and mortgage affordability measures on mortgage premia and default. Mortgage selection by heterogeneous borrowers helps explain the higher default rates on adjustable‐rate mortgages during the recent U.S. housing downturn, and the variation in mortgage premia with the level of interest rates.     

Loan-to-value policy and housing finance: Effects on constrained borrowers

This paper explores the effects of an LTV limit on constrained borrowers using comprehensive loan- and borrower-level data from Brazil. LTV limits entail identification challenges because constrained borrowers are no longer directly observed after the policy is implemented. In this paper, partially observed treatment status is addressed by an adjusted difference-in-difference method, focusing on the average treatment effect on the treated (ATT) borrowers (i.e. those that would violate the LTV limit if unconstrained). In the most affected segment, treated individuals cope with the new LTV limit by making higher down payments and also purchasing more affordable houses. They are also less likely to be in arrears, suggesting that LTV limits are effective macroprudential tools by lowering the risk of some originated housing loans.     

On the Effectiveness of Loan-to-Value Regulation in a Multiconstraint Framework

Models in the infinite horizon macro-housing literature often assume that borrowers are constrained exclusively by the loan-to-value (LTV) ratio. Motivated by the Swedish microdata, I explore an alternative arrangement where borrowers are constrained by a collateral constraint and by a debt-service-to-income ratio. While stricter LTV limits are often considered as a measure to tackle the rise in household indebtedness, I find that policy designed to lower the maximum permissible LTV ratio may actually leave the debt-to-GDP ratio unchanged and increase housing prices in equilibrium if borrowers are bound by two constraints at the same time.