Market-Based Loss Mitigation Practices for Troubled Mortgages Following the Financial Crisis
AbstractThe meltdown in residential real-estate prices that commenced in 2006 resulted in unprecedented mortgage delinquency rates. Until mid-2009, lenders and servicers pursued their own individual loss mitigation practices without being significantly influenced by government intervention. Using a unique dataset that precisely identifies loss mitigation actions, we study these methods--liquidation, repayment plans, loan modification, and refinancing--and analyze their effectiveness. We show that the majority of delinquent mortgages do not enter any loss mitigation program or become a part of foreclosure proceedings within 6 months of becoming distressed. We also find that it takes longer to complete foreclosures over time, potentially due to congestion. We further document large heterogeneity in practices across servicers, which is not accounted for by differences in borrower population. Consistent with the idea that securitization induces agency conflicts, we confirm that the likelihood of modification of securitized loans is up to 70% lower relative to portfolio loans. Finally, we find evidence that affordability (as opposed to strategic default due to negative equity) is the prime reason for redefault following modifications. While modification terms are more favorable for weaker borrowers, greater reductions in mortgage payments and/or interest rates are associated with lower redefault rates. Our regression estimates suggest that a 1 percentage point decline in mortgage interest rate is associated with a nearly 4 percentage point decline in default probability. This finding is consistent with the Home Affordable Modification Program (HAMP) focus on improving mortgage affordability.
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Bibliographic InfoPaper provided by Ohio State University, Charles A. Dice Center for Research in Financial Economics in its series Working Paper Series with number 2010-19.
Date of creation: Oct 2010
Date of revision:
Other versions of this item:
- Sumit Agarwal & Gene Amromin & Itzhak Ben-David & Souphala Chomsisengphet & Douglas D. Evanoff, 2011. "Market-based loss mitigation practices for troubled mortgages following the financial crisis," Working Paper Series WP-2011-03, Federal Reserve Bank of Chicago.
- D10 - Microeconomics - - Household Behavior - - - General
- D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
- G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
- G20 - Financial Economics - - Financial Institutions and Services - - - General
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