Information lenders cannot see about struggling borrowers can make the difference between mortgage relief and foreclosure, according to a Cornell economist’s study of loans made before the 2008 financial crisis.
Lauri Kytömaa’s model estimated that gaps between what borrowers and lenders know increased total foreclosures by 22% compared with a scenario in which borrowers’ financial information was fully available. Incentive payments through the federal Home Affordable Modification Program reduced foreclosures by 3%, according to Cornell Chronicle’s account of the research.
Why a borrower’s private information matters
Kytömaa, an assistant professor of applied economics and policy and Torgalkar Faculty Fellow in Cornell’s SC Johnson College of Business, examined how lenders decide whether to offer debt relief when processing assistance is costly and borrowers know things about their finances that lenders do not.
Those unknowns can cut in either direction. A homeowner may anticipate losing a job or facing an expensive divorce. Another may have access to family lending that could help cover mortgage payments. Lenders making decisions through formulas or algorithms may lack that information.
“Institutions didn’t know exactly who needed the aid and who didn’t,” Kytömaa told Cornell Chronicle.
His paper, “The Roles of Borrower Private Information and Mortgage Relief Design in Foreclosure Prevention,” was published Nov. 9 in The Review of Economic Studies, according to Cornell.
Model draws on 162,000 California loans
The analysis used a sample of 162,000 Fannie Mae-guaranteed mortgages originated in California from 2004 through 2007. Kytömaa modeled the interaction between borrowers and loan servicers as a debt-relief process that ends in repayment or foreclosure.
The model allowed borrowers to hold private information about their willingness to miss payments temporarily and become delinquent, as well as their willingness to default. It also weighed foreclosure transaction costs against the assistance needed to keep a financially distressed homeowner making payments.
The research examined the historical effects of the Home Affordable Modification Program, which provided reduced monthly mortgage payments to struggling homeowners. Its findings distinguish the effects of program incentives from the larger role that incomplete borrower information played in the model.
The 22% estimate compares modeled foreclosures with an outcome in which all borrower information was available. It is not a measurement of a current nationwide increase in foreclosures, and the study’s loan sample was from California.
Private information can extend beyond income and debt. Housing alternatives and a family’s attachment to a school system can influence how hard borrowers work to remain in their homes, Kytömaa said.
Foreclosure also carries costs for lenders
Cornell’s account notes that U.S. loan servicers foreclosed on 7.8 million homes between 2007 and 2016. Kytömaa said lenders lost, on average, about 40% of the outstanding principal balance through foreclosures during the crisis, raising the question of whether smaller payment reductions could have produced better outcomes for some borrowers and lenders.
That does not mean every foreclosure should be prevented. Kytömaa said foreclosure remains a way for lenders to recover unpaid debt, and eliminating it entirely would be unrealistic and unwise.
He said foreclosures had remained historically low for several years but had recently increased amid a housing-market slowdown. He characterized conditions as nowhere near the 2008 crisis. Falling property values can make it harder for borrowers to sell a home and repay their debt, he said.
The lesson for lenders, he said, is to make better-informed mortgage-relief decisions, particularly when declining property prices can deepen losses from widespread foreclosures.
Cornell University exterior file photo. This image does not depict the mortgage study or properties included in its analysis. FingerLakes1.com archive.
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