Abstract
This paper proposes a novel system-wide multi-state framework to model state occupations and the transitions among current, delinquency, default, prepayment, repurchase, short sale and foreclosure on mortgage loans. The approach allows for the modelling of the progression of borrowers from one state to another to fully understand the risks of a cohort of borrowers over time. We use a multi-state Markov model to model the transitions to and from various states. The key factors affecting the transition into various loan outcomes are the ability to pay as measured by debt-to-income ratio, equity as marked by loan-to-value ratio, interest rates and the property type. Our findings have broader policy implications for better decision-making on granting loans and the design of debt relief and mortgage modification policies.
Highlights
Housing wealth is typically the largest component of wealth for many households and mortgages are their main source of credit (Campbell 2013)
During the recent global financial crises, mortgage debt triggered a wave of foreclosures that impacted household consumption, balance sheets as well as the transmission of monetary policy to the real economy (Mian et al 2015; Di Maggio et al 2017)
There was an ushering of significant monetary policy changes which lowered interest rates to historic lows levels; the introduction of two large-scale debt relief programs, namely the Home Affordable Refinancing Program (HARP) and the Home Affordable
Summary
Housing wealth is typically the largest component of wealth for many households and mortgages are their main source of credit (Campbell 2013). The study goes beyond modelling default or foreclosure as the only risk on mortgages or the competing risks of prepayment and foreclosure to include transient states of delinquency to allow the modelling of recovery or cure from distress as well as introducing additional absorbing states of repurchase and short sale into the multi-state framework. Using this framework, we investigate the relationship between the probability of loans transitioning to and from various loan outcomes and loan-level covariates.
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