MBA RIHA Report: Mortgage Industry Should Develop New Intervention Policies For Distressed Borrowers

Events such as the Great Financial Crisis and the COVID-19 pandemic caused high levels of housing market stress, leading to rising mortgage delinquencies. According to a new research report by the Mortgage Bankers Association’s (MBA) Research Institute for Housing America (RIHA), examining current mortgage design models, underwriting standards, and intervention policies would help alleviate market pressures resulting from high levels of mortgage defaults.

“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.”

Added Tracy, “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.”

Mortgage Design, Underwriting, and Interventions: Promoting Sustainable Homeownership, RIHA’s study, focuses on the lessons learned from the Great Financial Crisis and the recent COVID-19 pandemic to understand how to design a more robust system of mortgage finance that proactively supports sustainable homeownership to better prepare for future periods of housing market stress. The paper outlines a taxonomy 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.

“The study’s findings can help the industry identify current issues impacting overall housing sustainability and how to prep for future housing downturns,” said Edward Seiler, Executive Director, Research Institute for Housing America, and MBA’s Associate Vice President, 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.”

Key findings of Mortgage Design, Underwriting and Interventions: Promoting Sustainable Homeownership include:

• There are three basic situations that lead to mortgage default.
• Strategic default occurs when borrowers have the ability to pay their mortgage but choose to default due to being in negative equity.
• Double-trigger default occurs when a borrower is unable to pay their mortgage due to a liquidity shock – income or payment – and cannot sell their home due to negative equity.
• 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 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.