Issues in Mortgage Design

Paper Session

Friday, Jan. 6, 2017 8:00 AM – 10:00 AM

Sheraton Grand Chicago, Ontario
Hosted By: American Real Estate and Urban Economics Association
  • Chair: Anthony Sanders, George Mason University

Evaluating Loan Modifications: 2008 - 2014

Susan Wachter
,
University of Pennsylvania
Min Hwang
,
George Washington University
Inwon Jang
,
Office of the Comptroller of the Currency

Abstract

After the nationwide housing market collapse, there were many policy efforts by various government agencies as well as private proprietary programs on loan modification. This is one of the most important developments in the U.S. mortgage markets since the financial crisis. We evaluate the performance of loan modification with two distinctive advantages over the existing studies. First, we use Mortgage Metrics database which, covering 70% of the U.S. mortgage market, includes various loan groups such as FHA, GSE and portfolio loans to review the performance of modified mortgage loans. Second, we develop a methodology to individually assess the effects of each modified term measured by impact on present value of the mortgage. A mortgage loan is typically modified on several terms at the same time such as interest rates, loan maturities and principal payments. It is difficult to assess the individual effects of modified terms since all the loan terms have measurement units difficult to compare each other. We propose a method to address those issues for consistent estimation of effects of individual loan terms. We find that, among the modified loans in our dataset, principal deferments have the largest effect on the probability of re-default for a 1% change in present value of a modified loan, followed by interest rate reductions. We find evidence that the principal reduction has strong effects as well. But when the effect is measured in terms of a 1% change in the present value of the loan, it is smaller than the effect of a principal deferment or of an interest rate reduction.

Automatic Workout Mortgage and Housing Consumption Choice

Rafal Wojakowski
,
University of Surrey
Robert J. Shiller
,
Yale University
Muhammed-Shahid Ebrahim
,
Durham University
Mark Shackleton
,
Lancaster University

Abstract

This paper proposes an innovative mortgage contract with an endemic insurance to alleviate negative equity, systemic risk and revive the economy. We term this as an Automatic Workout Mortgage (AWM) and model it mathematically. Our efforts yield the following results. Demand for housing increases if AWM is employed and attains maxima for those intending to reverse-mortgage 40% of equity (without workout) and about 80% of equity (with AWM). We therefore assert that AWM is particularly suited for those who intend to sell or reverse-mortgage a significant fraction of their home equity before retirement. Insurance provided via AWM inhibits precautionary saving motives by making housing more attractive to risk averse borrowers. Consumption is reduced as more housing is purchased and borrowing increased. AWM improves expected utility by a dollar equivalent of about 38% to 56% of the initial value of the house $100,000. AWM protect the value acumulated in the home equity and thus facilitate future migration to a more suitable property. In this respect AWMs also improve future housing affordability, especially at the retirement age.

Making Homeownership More Accessible by Improving the Fixed-Rate Mortgage

Wayne Passmore
,
Federal Reserve Board

Abstract


When it was first developed over 50 years ago, the 30-year fixed-rate fully-amortizing mortgage (or “traditional fixed-rate mortgage”) represented a substantial innovation in the mortgage market; however, it has three major flaws. First, since homeowner equity accumulates slowly during the first decade, homeowners are essentially renting their homes from lenders. With so little equity accumulation, many lenders require large down payments. Second, in each monthly mortgage payment, homeowners substantially compensate capital markets investors for the ability to prepay. The homeowner might have better uses for this money. Finally, refinancing mortgages is often very costly.
I propose a new fixed-rate mortgage, which is called the fixed-payment-COFI mortgage (or “the fixed-COFI mortgage”), that resolves the three problems with the traditional fixed-rate mortgage. This mortgage has fixed monthly payments equal to payments for traditional fixed-rate mortgages and no down payment. Also, unlike traditional fixed-rate mortgages, fixed-COFI mortgages do not bundle mortgage financing with insurance products to compensate capital markets investors for bearing prepayment risks; products many homeowners do not need.
The fixed-COFI mortgage exploits the often-present prepayment-risk wedge between the fixed-rate mortgage rate and the estimated cost of funds index (COFI) mortgage rate. Committing to a savings program based on the difference between fixed-rate mortgage payments and payments based on COFI plus a margin, the homeowner uses this wedge to accumulate home equity quickly. In “normal” times, the fixed-COFI mortgage leads to rapid home equity accumulation by the household (almost always resulting in homeownership) and remains a highly profitable asset for the mortgage lender.
The fixed-COFI mortgage may help renters, who are paying rents as high as comparable mortgage payments in high-cost metropolitan areas and do not have enough savings for a down payment, gain access to homeownership

Does Differential Treatment Translate to Differential Outcomes for Minority Borrowers? Evidence from Matching a Field Experiment to Loan-Level Data

Andrew Hanson
,
Marquette University
Zackary Hawley
,
Texas Christian University
Hal Martin
,
Federal Reserve Bank of Cleveland

Abstract

This paper provides evidence on the relationship between differential treatment of minority borrowers and differential loan outcomes in the mortgage market. Using data from a field experiment that identifies differential treatment matched to real borrower transactions in the Home Mortgage Disclosure Act (HMDA) data, we estimate difference-in-difference models between African American and white borrowers across lending institutions that display varying degrees of differential treatment. Our results show that African Americans are more likely to be in a high cost (sub-prime) loan when borrowing from lenders that are more responsive to them in the field experiment. We also show that net measures of differential treatment are not related to the probability of African American borrowers having a high cost loan. Our results suggest that differential outcomes are related to within institution factors like client steering, not just across institutional factors like access as previous studies find.
Discussant(s)
Robert Van Order
,
George Washington University
Brent Ambrose
,
Pennsylvania State University
Carlos Slawson
,
Louisiana State University
Richard Martin
,
University of Georgia
JEL Classifications
  • G2 - Financial Institutions and Services
  • J1 - Demographic Economics