Estimating Environmentally Adjusted Risks of Mortgage Arrears for Different Socioeconomic Groups of Borrowers

Purpose: The proper consideration of risk factors that can lead to the failure of a borrower to repay a mortgage is critical for both mortgage borrowers and lending institutions. Models for assessing the risk of mortgage arrears (MA) typically incorporate loan attributes and essential characteristics of the borrower, including net income, family size, age, education, and credit history. However, such standard MA models exclude environmental risk factors, which increase, as we hypothesize, the MA risk. Design/Methodology/Approach: We analyzed 90,000 individual mortgage records obtained from a leading commercial bank in Israel to verify this hypothesis. In the analysis, the mortgage records were geo-referenced by their seven-digit ZIP codes and linked to air pollution data and several other locational attributes. The analysis was performed using a Cox-type proportional hazard model. Findings: The study shows that residential exposure to high levels of air pollution tends to increase the MA risk by about 10%–25%, depending on the type of air pollutant and exposure level. We attribute this finding to the fact that exposure to air pollution may reduce productivity and increase work absenteeism, thus making mortgage repayment more difficult. Practical implications: The importance of the study is due to its three main novelty aspects: First, it suggests an empirical approach to adjusting MA risk estimates by accounting for environmental attributes of residential properties. Second, the analysis shows that borrowers' and mortgage's attributes (such as net monthly income, family size, and LTV ratio) tend to increase the MA risk asymmetrically for different groups of borrowers. Originality: The study demonstrates the utility of adding air pollution variables to the list of MA risk predictors, which helps to introduce important information not captured by other observables. To the best of our knowledge, this is the first study that assesses environmentally adjusted MA risks for different socioeconomic groups of borrowers.