According to new research from the Mortgage Bankers Association’s (MBA) Research Institute for Housing America (RIHA), examining current mortgage design models, underwriting standards, and intervention policies could help alleviate market pressures resulting from high levels of mortgage defaults.
“Mortgage Design, Underwriting, and Interventions: Promoting Sustainable Homeownership,” RIHA’s study, focuses on the lessons learned from the Great Financial Crisis and the COVID-19 pandemic to understand how to design a more robust system of mortgage finance that supports sustainable homeownership to better prepare for future periods of housing market stress.
“The mortgage industry has faced numerous challenges that have caused mass upheaval in the housing market, and in many cases, the industry was ill-prepared to handle the significant influx of mortgage defaults and subsequent foreclosures,” said Dr. Joseph Tracy, a distinguished fellow at Purdue University and former Senior Federal Reserve Advisor. “The industry must continue to evolve with the changing dynamics of its customers and their needs. By examining current mortgage design and underwriting standards, the industry will be better equipped to assist distressed borrowers facing hardships.”
Proper Preparation
“Mortgage Design, Underwriting, and Interventions: Promoting Sustainable Homeownership” outlines characteristics of mortgage defaults based on the borrower’s equity position, and whether the borrower faced a liquidity shock. The paper also discusses how sustainable homeownership involves addressing the varying needs of borrowers to minimize defaults.
“Refocusing on sustainability will ensure that future gains in the homeownership rate are enduring and that households are more likely to attain their aspiration of one day owning their home debt free,” said Dr. Tracy.
Key Findings
According to the report, there are three basic situations that lead to mortgage default. The first is strategic default that occurs when borrowers have the ability to pay their mortgage, but choose to default due to being in negative equity. Second, double-trigger default occurs when a borrower is unable to pay their mortgage due to a liquidity shock, such as income or payment, and cannot sell their home due to negative equity. Third, cash-flow defaults occur when the borrower is unable to pay their mortgage due to a liquidity shock and chooses not to sell their home even though they have positive equity.
“The study’s findings can help the industry identify current issues impacting overall housing sustainability and how to prep for future housing downturns,” said Dr. Edward Seiler, Executive Director, RIHA, and MBA’s Associate VP, Housing Economics. “Creating solutions for distressed borrowers will greatly improve the efficiency in the housing market as well as provide additional ways to make sure distressed borrowers stay in their homes.”
Additional findings include:
- The aim when intervening with a distressed borrower is not to limit foreclosures (or to maximize the success of the intervention), but rather to minimize the loan’s expected loss.
- Calculating the expected loss from foreclosure requires an estimate of the average loss associated with a foreclosure and the likelihood that a borrower in default will cure.
- For any intervention, estimates are needed for the average losses if the intervention is successful and if it fails, as well as the likelihood that the intervention will be successful (that is the borrower will not redefault). The design of the intervention will affect each of these three components.
- Two key strategies for helping distressed borrowers are to mitigate any cash-flow constraints and to deleverage the borrower.
- Improving the robustness of housing finance and sustainable homeownership requires examining mortgage design, underwriting, and intervention policies for addressing stressed mortgage borrowers.
MBA’s RIHA is a 501(c)(3) trust fund. RIHA’s purpose is to encourage and assist–through grants to distinguished scholars and subject matter experts, educational institutions, research facilities, and government organizations–establishment of a broader-based knowledge of mortgage banking and real estate finance.
Click here to access the full report “Mortgage Design, Underwriting, and Interventions: Promoting Sustainable Homeownership.”
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