The Impact of Homeowners' Housing Wealth Misestimation on Consumption and Saving Decisions

Using a unique data set of 81,943 house value estimates by the homeowners and their financial institution, I find that homeowners overestimate their house value by 3.1%. After controlling for homeowners' socioeconomic characteristics, I find that ex ante homeowners who rate (cash-out) refinance an existing loan to increase savings (consumption) are significantly more likely to underestimate (overestimate) their house value. Moreover, overestimators (underestimators) are more likely to increase (reduce) their spending ex post . Finally, I also find that underestimators are more likely to prepay their loans and overestimators are more likely to default on their loans.     

Mortgage Refinancing with Asymmetric Information

Information asymmetry exists between the lender and the borrower regarding the holding period of the mortgaged real estate; the lender does not know how long the borrower plans to own the house. This information asymmetry allows the cost of obtaining a mortgage to deviate from its value to the borrower. As a result, the exercise price of the option to refinance becomes the cost to the borrower of obtaining a new mortgage instead of the outstanding balance of the existing mortgage as used in previous models. The option to refinance is a sequential option; after the borrower refinances, a new option is obtained to refinance again in the future. A mortgage refinancing model is developed taking information asymmetry and sequential refinancing into account. The model is used to solve for (1) the value to the borrower of a callable mortgage and (2) the minimum interest rate differential between the contract rate of the existing mortgage and the market interest rate needed to justify refinancing.     

Some Loans Are More Equal than Others: Third–Party Originations and Defaults in the Subprime Mortgage Industry

We show how agency problems between lenders (principals) and third–party originators (TPO; agents) imply that TPO–originated loans are more likely to default than similar retail–originated loans. The nature of the agency problem is that TPOs are compensated for writing loans, but are not completely held accountable for the subsequent performance of those loans. Using a hazard model with jointly estimated competing risks and unobserved heterogeneity, we find empirical support for the TPO/default prediction using individual fixed–rate subprime loans with first liens secured by residential real estate originated between January 1, 1996, and December 31, 1998. We find that apparently equal loans (similar ability to pay, option incentives and term) can have unequal default probabilities. We also find that, initially, the agency–cost risk was not priced. At first, the market did not recognize the higher channel risk, since TPO and retail loans received similar interest rates even though the TPO loans were more likely to default. We also show that this inefficiency was short–lived. As the difference in default rates became apparent, interest rates on TPO loans rose about 50 basis points above otherwise similar retail loans.     

Do Riskier Borrowers Borrow More?

Conventional wisdom in the mortgage industry holds that loan-to-value (LTV) ratios are positively correlated with mortgage default rates. However, not all empirical studies of mortgage loan performance support this view. This paper offers a theoretical signaling model of why the correlation between LTV ratios and default risk is contingent upon the default costs of the borrower. Specifically, the model proposes that when default costs are high there exists a separating equilibrium in which risky borrowers will self-select into lower LTV loans to reduce the probability of facing a costly default, while safe borrowers will self-select into higher LTV loans as a signal of their enhanced creditworthiness. This adverse selection process gives rise to the possibility of higher default probabilities for lower LTV loans. Conversely, when default costs are low the conventional result, in which risky borrowers select higher LTV loans than safe borrowers, is obtained. Empirical results, based on a sample of 859 single-family residential mortgage loans drawn from the portfolio of a national mortgage lender, are consistent with the separating equilibria predicted by the model.     

The Effect of Mortgage Payment Reduction on Default: Evidence from the Home Affordable Refinance Program

This article evaluates the effect of payment reduction on mortgage default within the context of the Home Affordable Refinance Program. We find that mortgage default is sensitive to payment reduction using univariate, duration and hazard modeling approaches. A relative risk Cox model of default with time‐varying covariates estimates that a 10% reduction in mortgage payment is associated with about a 10–11% reduction in monthly default hazard for loans. This finding is robust to the inclusion of empirically important mortgage risk drivers (such as current loan‐to‐value and FICO score) as well as controlling for selection effects based on observables.     

Explaining Refinancing Decisions Using Microdata

This paper develops a model which explains how mortgage-rate movements, transactions costs, changes in borrower income and house value, personal financial opportunities and the prepayment option embedded in fixed-rate mortgages affect a financially flexible borrower's decision to refinance an existing loan while retaining the underlying home. Broadening the focus of previous analytical work, the model explains why households with similar mortgage loans may react differently as financial market conditions change. It contains definitive empirical predictions that are supported by an analysis of a choice-based sample of individual loan transactions. Results suggest that refinancings are motivated both by movements in the level of interest rates and by borrowers' desires to alter their capital structures in the face of changing income and housing wealth.     

The Impact of Second Loans on Subprime Mortgage Defaults

An estimated 12.6% of primary mortgage loans were simultaneously originated with a second loan from 2004 until 2008, although relatively little is known about how the presence of such subordinate loans affects the default decisions of borrowers. We use a novel data series of loan servicing records from 2002 until 2010 to identify such borrowers and find evidence that the default behavior of these borrowers significantly differs from borrowers without second loans. Estimating a discrete‐time proportional odds hazard model, we find borrowers with a second loan were 62.7% more likely to default each month on their primary loan when conditioning alone on the attributes of the primary loan. However, borrowers of second loans were 58.3% less likely to default on their primary loan as compared to single‐loan borrowers with equivalent current combined attributes (i.e., loan‐to‐value, balance and interest rate). We hypothesize and provide empirical evidence that this occurs because borrowers with second loans have the option to sequentially default on each loan since subordinate lenders will not pursue foreclosure if borrowers have insufficient equity. Lenders of defaulted subordinate debt may revisit their decision to foreclose in the future after housing markets start to recover, thus prompting a new round of foreclosures.     

Housing Finance in the 1980's

Strains evident in the housing finance system on the eve of the 80's suggest significant difficulties in meeting the housing demands of the decade ahead. The annual increase in residential mortgages outstanding had climbed to historic levels, relative to GNP, without raising residential construction spending above its ordinary share of GNP. This very weak housing bang for the mortgage buck is traceable, ultimately, to the soaring volume of sales in the used home market, relative to those in the new home market. With significant inflation rates continuing through the 1980's, mortgage lenders will be under great pressure from demands to refinance the existing housing stock, even if the rate of ownership turnover does not persist at the levels of the late 70's. And, as the dollar demands mount, for new and used housing purchases, lenders may find repayment flows from earlier loans continuing to provide a historically small fraction of the funds they need in supplying these demands.     

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.     

A Note on Mortgage Risk: Default vs. Loss Rates

This note reexamines the role of the loan-to-value ratio on mortgage risk. Whereas previous studies have focused on the default rate as a function of this term, this study considers the additional effect on the loss rate of defaulted loans. Because the dollar loss per amount originated is the product of the default rate and the loss rate on defaulted loans, the impact of the loan-to-value ratio on both the default and loss rates is crucial to explaining the impact of the loan-to-value ratio on mortgage risk. I find that both rates are significantly positively related to loan-to-value ratio and that the loss rate accounts for between 13% and 20% of total loan-to-value impact.     

The information value of online social networks: Lessons from peer-to-peer lending

We examine whether social networks facilitate online markets using data from a leading peer-to-peer lending website. We find that borrowers with social ties are consistently more likely to have their loans funded and receive lower interest rates; however, most borrowers with social ties are more likely to pay late or default. We provide evidence that these findings are driven by lenders not fully understanding the relationship between social ties and unobserved borrower quality. Overall, our findings suggest caution for using online social networks as a signal of quality in anonymous transactions.     

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.     

Search Cost and Price Dispersion in Vertically Related Markets: The Case of Bank Loans and Deposits

Using data on marginal interest rates of loan and deposit products by Spanish banks, we find that the level of interest rates on loans (deposits) across geographic markets decrease (increase) with the number of banks in each market, and that the level of interest rates on loans increases with the level of interest rates of deposits. We also find that the dispersion of interest rates of both loans and deposits increase with the number of banks. This evidence is interpreted as evidence of customer’s search costs in retail banking, consistent with predictions from the Carlson and McAfee (J Polit Econ 91:480–493, 1983) model of market competition with search costs.     

The Termination of Subprime Hybrid and Fixed‐Rate Mortgages

Adjustable‐rate and hybrid loans have been a larger component of subprime mortgage lending in the mortgage market than prime lending. The typical adjustable‐rate loan in subprime is a hybrid of fixed and adjustable characteristics in which the first 2 years are fixed and the remaining 28 years adjustable. Hybrid loans terminate at elevated probabilities even before the first adjustment date. Hybrid loan terminations are sensitive to interest rates and teaser rates (payment shocks). Default probabilities increase dramatically when payment shocks are mixed with low or no equity in the home. This is the mixture of events that helped to trigger the 2007/2008 subprime mortgage crisis.     

Movers and Shuckers: Interdependent Prepayment Decisions

We model competing risks of mortgage termination where the borrower faces a repeated choice to continue to pay, refinance the loan, move or default. Most previous empirical work on mortgage prepayment has ignored the distinction between prepayments triggered by refinancing and moving, combining them into a single prepayment rate. We show that financial considerations are the primary drivers of the refinance choice while homeowner characteristics have more influence on the move decision. We demonstrate that these differences are statistically significant and that combining these two distinct choices into a single measure of prepayment shifts coefficients toward zero and produces inaccurate predictions of aggregate termination rates. For example, a combined model underestimates the effect of the market price of the loan on refinancing; it misses entirely the opposite effects of borrower income on moving and refinancing. Our results suggest that existing prepayment models are inconsistent predictors of mobility-driven prepayment and underestimate the effect of market conditions and borrower characteristics on refinancing and housing decisions. Our findings have great significance to mortgage investors because mobility-driven prepayments are likely to be a more significant source of prepayments in thenext decade.     

Semivariance of Property Value Estimates as a Determinant of Default Risk

Standard practice in the residential mortgage underwriting industry is to estimate collateral values via independent appraisals conducted by third parties. This paper empirically examines the role of property value ( i.e. , appraisal) uncertainty as a determinant of default on residential mortgage loans. Based upon an analysis of 1,428 residential loans drawn from the portfolio of a national mortgage lender, we find evidence that semivariance in property value uncertainty is related to default risk. Specifically, subject properties that are valued above the sales price of recently sold "similar and proximate" properties show evidence of greater default risk. Interestingly, a variance (range) measure of property value uncertainty is not significantly related to default risk.     

Contemporaneous Loan Stress and Termination Risk in the CMBS Pool: How “Ruthless” is Default?

This study analyzes the impact of contemporaneous loan stress on the termination of loans in the commercial mortgage‐backed securities pool from 1992 to 2004 using a novel measure, based on changes in net operating incomes and property values at the metropolitan statistical area‐property‐type‐year level. Employing a semi‐parametric competing risks model for a variety of specifications, we find that the probability of default is extremely low even at very high levels of stress, although the coefficient estimates of greatest interest are very statistically significant. These results suggest substantial lender forbearance and are consistent with previous research that models default as a “gradual dynamic process” rather than a “ruthless” exercise once “in the money.”     

Unobserved Heterogeneity in Models of Competing Mortgage Termination Risks

This article extends unobserved heterogeneity to the multinomial logit (MNL) model framework in the context of mortgages terminated by refinance, move or default. It tests for the importance of unobserved heterogeneity when borrower characteristics such as income, age and credit score are included to capture lender-observed heterogeneity. It does this by comparing the proportional hazard model to MNL with and without mass-point estimates of unobserved heterogeneous groups of borrowers. The mass-point mixed hazard (MMH) model yields larger and more significant coefficients for several important variables in the move model, whereas the MNL model without unobserved heterogeneity performs well with the refinance estimates. The MMH clearly dominates the alternative models in sample and out of sample. However, it is sometimes difficult to obtain convergence for the models estimated jointly with mass points.     

Income, Location and Default: Some Implications for Community Lending

This paper investigates differences in default losses across income groups and neighborhoods, in an effort to see if there are significant differences between default experience on loans to low-income households or low-income neighborhoods and other loans. We find that while defaults and losses are somewhat higher in low-income neighborhoods, default behavior is similar in the sense that responses to negative equity are similar across neighborhoods, and remaining differences are small and might be explained by omitted variables such as those measuring credit history.     

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.