Adjustable-Rate Mortgages, Economic Fluctuations, and Lender Portfolio Change

In this study we examine the effects of economic fluctuations on the repayment behavior of a portfolio of adjustable-rate mortgages (ARMs). Because the U.S. experience with ARMs is quite recent, we have used data on a form of ARM used in Canada, the rollover mortgage. The results of our analysis suggest that use of ARMs similar to the rollover mortgage may reduce but not eliminate interest-rate risk for lenders, as borrowers, albeit constrained, prepay above-market-rate loans. In addition, we find that the periodic payment change inherent in the rollover mortgage does not lead to higher default rates and, therefore, credit risk.     

Estimating Borrower Mobility from Observed Prepayments

This article describes a method used to estimate parameters describing the mobility of borrowers choosing fixed-rate mortgages. Using a mortgage valuation model that predicts prepayments contingent upon parameters describing the distribution of expected tenure in the home, the average mobility of borrowers can be estimated from observed prepayment behavior. This article estimates the mobility of borrowers who chose fixed-rate mortgages before 1980 and borrowers who chose similar mortgages in the second half of the 1980s, when adjustable-rate mortgages were widely available. The empirical results support the claim that the average mobility of fixed-rate borrowers has declined.     

Interest Rate Risk, Residential Mortgages and Financial Futures Markets

Residential mortgage markets in both the United States and Canada have recently been dominated by instruments such as variable-rate and short-term rollover mortgages which require borrowers to assume a greater burden of interest rate risk. An outstanding question is whether this approach to risk allocation is Pareto optimal or whether there are other more effective methods of dealing with the risk created by interest rate volatility. This study examines the potential for shifting this risk from the mortgage market to the financial futures market. After considering the rationale for expecting that neither mortgage borrowers nor lenders wish to absorb the high levels of risk present in the existing financial environment, this study discusses the hedging of interest rate risk through financial futures markets. Empirical tests are then performed to evaluate the effectiveness of U.S. futures markets for hedging positions from the U.S. mortgage market. These results indicate that the interest rate risk inherent in residential mortgages can be substantially shifted through one or more positions in the existing futures contracts and long-term, fixed-rate mortgages may still be financially feasible under conditions of interest rate volatility.     

Mortgage Borrower Repayment Behavior: A Microeconomic Analysis with Canadian Adjustable Rate Mortgage Data

In this paper we estimate a model of mortgage borrower behavior using micro-level data on Canadian borrowers with rollover mortgages—a form of adjustable-rate mortgage. Our results suggest that the probability of default rises with a decrease in housing equity and an increase in the mortgage contract rate; however the size of these changes is relatively small. They also show that partial prepayment is sensitive to fluctuations in the rates of return from investing in housing versus other assets. For the United States experience, our results suggest that, relative to fixed-rate mortgage borrowers, adjustable-rate mortgage borrowers are more likely to default and less likely to prepay.     

Origination Channel,Prepayment Penalties and Default

This article presents evidence that nonbank‐originated subprime mortgages have a higher probability of default than bank‐originated subprime mortgages, but only for loans with prepayment penalties. Evidence also indicates that nonbanks price prepayment penalties less favorably to borrowers than banks do, and nonbanks originate disproportionately more loans with prepayment penalties in locales with less financially sophisticated borrowers. State antipredatory lending law provisions restricting the use of prepayment penalties eliminate the elevated default risk of nonbank originations relative to bank originations. These findings are consistent with incentives generated by nonbank compensation via yield spread premiums on loans with prepayment penalties.     

Per-customer quantity limit and price discrimination: Evidence from the U.S. residential mortgage market

Theoretically, if firms face a regulatory per-customer quantity limit, they should have an incentive to discriminatively charge high-demand customers higher prices and make them just willing to buy a quantity equal to the limit. In the U.S. residential mortgage industry, mortgages with origination balances above the conforming loan limits cannot be guaranteed by government-sponsored enterprises, which make lenders face a per-customer quantity limit. This paper finds that borrowers bunching at the limit pay higher interest rates due to price discrimination. This study rules out the alternative explanation that those borrowers are of higher risk (lending cost) than other borrowers.     

Differential Access to and Pricing of Home Mortgages: 2004 through 2009

This article documents trends and drivers of the residential mortgage market during the years 2004 through 2009, specifically focusing on the access to and pricing of mortgages originated by African‐American and Hispanic borrowers, and by borrowers living in low‐income and minority communities. Our analysis relies on a rich set of proprietary data that allow more expanded insights than can be obtained from the Home Mortgage Disclosure Act (HMDA) alone. We show that access to mortgage credit increased between 2004 and 2006 for the borrowers we focus on in our study and declined dramatically thereafter. Trends in access to credit were driven primarily by the changing credit mix of mortgage applicants and secondarily by the replacement of the Federal Housing Administration (FHA) for subprime as the dominant mode of nonprime originations and tighter underwriting standards. Throughout our entire period of study, these borrowers also consistently paid higher prices for their mortgages; however, the extent of this differential varied considerably over time and across groups. These pricing trends were driven primarily by changes in the FHA and subprime shares as well as by the market's increasingly aggressive pricing of credit risk.     

Why Mortgage Borrowers Persevere: An Explanation of First and Second Lien Performance Mismatch

Borrowers with a pair of mortgages collateralized by the same property sometimes continue to make payments on one while defaulting on the other. We articulate a framework for understanding this performance mismatch that emphasizes two types of borrowers: those with stable equity positions who perceive they are facing moderate or temporary liquidity shocks, and those facing severe financial stress in combination with negative equity. The former have an incentive to enter mismatch and subsequently cure, while the latter would default on both contracts. Our empirical analysis using newly available, national samples of matched first‐ and second‐lien mortgages supports this view.     

Reversing the Trend: The Recent Expansion of the Reverse Mortgage Market

Reverse mortgages allow elderly homeowners to tap into their housing wealth without having to sell or move out of their homes. However, very few eligible homeowners used reverse mortgages to achieve consumption smoothing until recently, when the reverse mortgage market in the United States witnessed substantial growth. In this article, I examine 1989–2007 loan‐level reverse mortgage data and conduct three sets of analyses to better understand the demand for reverse mortgages among elderly homeowners. First, I study the ZIP code characteristics correlated with reverse mortgage originations. Second, I show that recent reverse mortgage borrowers are significantly different from earlier borrowers in many respects. Third, I investigate the reasons why the reverse mortgage market experienced substantial growth in the mid‐2000s. Combining the reverse mortgage data with county‐level house price data, I find that higher house prices lead to more reverse mortgage originations. Specifically, the increases in house prices account for about one‐third of the overall growth in the reverse mortgage market from 2003 to 2007.     

Residential Mortgage Markets and the Cost of Mortgage Funds

Early federal housing finance policy appears to have been largely directed at making mortgages more marketable. The creation of FHA, FNMA and FHLMC were designed to homogenize the mortgage instrument and to develop a secondary market for it. Apparently because of a lack of demand for marketability by investors, extensive trading of mortgages has not developed. Nonetheless, the fantastic growth in mortgage pools (as well as the unanticipated growth in FNMA holdings) has increased competition in the supplying of some intermediation functions (mortgage bankers have greatly expanded originations and servicing), has improved interregional flows of mortgage funds, and has given mortgage borrowers a greater access to capital markets generally. The principal result has been a decline in the mortgage rate relative to other market rates, although the inflation-triggered explosion in the demand for mortgage funds in recent years appears to be offsetting the impact of the growth in federal credit broadly defined.     

Thy Neighbor’s Mortgage: Does Living in a Subprime Neighborhood Affect One’s Probability of Default?

This article focuses on the potential externalities associated with subprime mortgage origination activity. Specifically, we examine whether negative spillover effects from subprime mortgage originations result in higher default rates in the surrounding area. Our empirical analysis controls for loan characteristics, house price changes and alternative loan products. Our results indicate that, after controlling for these characteristics, the concentration of subprime lending in a neighborhood does not lead to greater default risks for surrounding borrowers. However, we do find that more aggressive mortgage products (such as hybrid adjustable rate mortgages and low/no‐documentation loans) had significant negative spillovers on other borrowers. Stated differently, the aggressive alternative mortgage designs were more toxic to the housing and mortgage market than previously believed.     

Mortgage Choice: What's the Point?

This article shows that, in the presence of transaction costs payable by borrowers on refinancing, it is possible to construct a separating equilibrium in which borrowers with differing mobility select fixed rate mortgages (FRMs) with different combinations of coupon rate and points. We also show that, in the absence of such costs, no such equilibrium is possible. This provides a possible explanation for the large menus of FRMs typically encountered by potential borrowers, and suggests that the menu available at the time of origination should be an important predictor of future prepayment. We numerically implement the model, developing the first contingent claims mortgage valuation algorithm that can quantify the effect of self-selection on real contracts in a realistic interest rate setting. The algorithm allows investors to account for self-selection when valuing mortgages and mortgage-backed securities. It also, for the first time, allows lenders to determine the optimal points/coupon rate schedule to offer to a specified set of potential borrowers, given the current level of interest rates.     

Subprime Refinancing: Equity Extraction and Mortgage Termination

This article examines the choice of borrowers to extract wealth from housing in the high-cost (subprime) segment of the mortgage market and assesses the prepayment and default performance of these cash-out refinance loans relative to the rate of refinance loans. Consistent with survey evidence, the propensity to extract equity is sensitive to the relative interest rates of other forms of consumer debt. After the loan is originated, our results indicate that cash-out refinances perform differently from non–cash-out refinances. For example, cash-outs are less likely to default or prepay, and the termination of cash-outs is more sensitive to changing interest rates and house prices.     

The Postforeclosure Experience of U.S. Households

Despite the recent flood of foreclosures on residential mortgages, little is known about what happens to borrowers’ households after their mortgages have been foreclosed. We study the postforeclosure experience of U.S. households using a unique data set based on the credit reports of a large panel of individuals from 1999 to 2010. Although foreclosure considerably raises the probability of moving, the majority of postforeclosure migrants do not end up in substantially less desirable neighborhoods or more crowded living conditions. These results suggest that, on average, foreclosure does not impose an economic burden large enough to severely reduce housing consumption.     

Refinancing Trends among Lower Income and Minority Homeowners during the Housing Boom and Bust

This article examines trends in mortgage refinancing activity during the housing boom and bust, with a focus on homeowners in lower income and minority market (LIMM) areas. Unlike any other period in recent history, during the boom LIMM homeowners refinanced their mortgages more frequently than non‐LIMM homeowners. This occurred primarily among borrowers for whom the refinance option was not in‐the‐money, and it is likely attributable to the concurrent growth of subprime, cash‐out refinancing. Following the 2007 mortgage market collapse, however, LIMM homeowners were less likely to refinance. This can be explained in part by systematic differences in home equity levels across borrowers.     

Simulation Analysis of Alternative Mortgage Instruments

The widespread concern over the inadequacies of the standard fixed rate, level payment mortgage instrument, especially in inflationary periods, has prompted a number of proposals for alternative mortgage instruments (AMIs). In this study the individual characteristics and economic implications of a number of AMIs are analyzed by simulating their behavior over different types of economic conditions. Each instrument is evaluated on the basis of its relative efficiency in accomplishing its particular objectives. Most of the instruments appear suitable for certain types of borrowers and lenders. However, this limited analysis suggests that the graduated payment and variable rate mortgages have advantages over the other variants considered. Various forms of each are already in use and appear to be relevant and marketable for many of the country's borrowers and lenders.     

Do Borrowers Make Rational Choices on Points and Refinancing?

Utilizing individual mortgage data, we find that borrowers with points are less likely to refinance, and when they do, they take longer to refinance. This finding supports the separating equilibrium prediction of earlier studies that borrowers with higher (lower) refinancing costs self‐select into mortgages with higher‐point/lower‐rate (lower‐point/higher‐rate) loans.     

Unobservable Risks in Mortgage Contract Choice

This study proposes a lifetime utility maximization model where borrowers choose optimal mortgage bundles including mortgage type, loan‐to‐value and loan size to maximize their allocation of limited budgets between housing and nonhousing consumptions. The model predicts that the mortgage bundle choices by borrowers of different income and risk attributes explain significant variations in the ex post default risks of the borrowers. The empirical tests using sampled mortgages pooled in nonagency residential mortgage backed securities support the hypothesis that the optimal choice of mortgage bundles reveals hidden risk factors of borrowers, which, if ignored, could lead to misjudgment of ex post default of borrowers.     

Foreclosure's Wake: The Credit Experiences of Individuals Following Foreclosure

While a substantial literature has examined the causes of mortgage foreclosure, there has been relatively little work on the consequences of foreclosure for the borrowers themselves. Using a large sample of anonymous credit bureau records, observed quarterly from 1999 through 2010, we examine the credit experiences of 330,000 borrowers before and after a foreclosure start. Our analysis documents the substantial declines in credit scores that accompany a foreclosure start and examines the length of time it takes individuals to return their credit scores to predelinquency levels. The results suggest that, particularly for prime borrowers, credit score recovery comes slowly, if at all. The lack of recovery appears to be driven by persistently higher delinquency rates on consumer credit (such as auto and credit card loans) in the years that follow their foreclosure start. Our results also indicate that the experiences of individuals whose mortgages entered foreclosure from 2007 to 2009 have followed a similar path to borrowers foreclosed earlier in the decade, though their postforeclosure‐start delinquency rates have been higher and, consequently, credit score recovery appears to be taking longer.     

The Government‐Sponsored Enterprises and the Mortgage Crisis: The Role of the Affordable Housing Goals

I use regression discontinuity analysis to measure the effect of one of the Affordable Housing Goals, the Underserved Areas Goal (UAG), on the number of whole single‐family mortgages purchased by Fannie Mae and Freddie Mac (GSEs) in undeserved census tracts for 1996–2002. Focusing additionally on tracts that became UAG‐eligible in 2005–2006, I measure the effect of the UAG during peak years for the subprime market. The results suggest a small UAG effect and challenge the view that the goals caused the GSEs to supply substantially more credit to high‐risk borrowers than they otherwise would have supplied during the subprime boom.