Residential Mortgage Market Research Articles

Counteroffers and Price Discrimination in Mortgage Lending

This study analyzes price discrimination and household switching in the residential mortgage market. Using a unique proprietary micro dataset from Norway, we examine the factors that influence a bank’s choice to counter an offer from a competing bank and the difference between the loan rate paid by current clients when receiving a competing offer from another bank and the concurrent best rate offered to new customers by the current bank. The estimates show that a bank employs internal information to decide how to counter a competing offer and that current clients pay approximately 20 basis points more than new customers. We surmise that new regulations and digitalization enhance transparency and can reduce the rate differential. However, introducing new banking products and changes in the timing of rate differentiation —from immediate upfront to gradually over time —may be used to maintain a constant rate differential.

How Do Banks Respond to Non-Bank Competition in the Conforming Residential Mortgage Market? The Role of Balance Sheet

How Do Banks Respond to Non-Bank Competition in the Conforming Residential Mortgage Market? The Role of Balance Sheet

Heat projections and mortgage characteristics: evidence from the USA

Climate change is increasingly acknowledged as a fundamental risk to the stability of the financial system. The linkage between residential mortgage lending and local heatwave projections has hitherto received little attention in the climate finance discourse despite recognition of the detrimental effects of extreme heat on economic output measures. Through economic, demographic and other channels, future climate conditions can affect the housing market and, thus, the residential mortgage market. Moreover, the potential for contagion is high considering US residential mortgages’ key role in financial cycles and cross-border effects. First, our paper furthers conceptual and empirical understandings of the nexus between future extreme heat and lenders’ credit risk. Second, for the contiguous US states, we show that interest rates are higher and loan terms are shorter in areas forecast to experience a larger increase in the number of hot days over the coming decades after controlling for a range of factors. Rate spreads are higher still in areas where the number of hot days is projected to be extreme. It is lending from non-banks, rather than banks, that appears sensitive to the changing climate.

The Rise of Nonbanks and the Quality of Financial Services: Evidence from Consumer Complaints

We show that as nonbanks' market share increases in a local residential mortgage market, the quality of mortgage services in the market improves. Two instrumental variable analyses exploiting (1) stress tests conducted by the Federal Reserve, and (2) mortgage industry surety bonds required by each state confirm this finding. We find evidence that as nonbanks grow their market share, they develop a specialty in servicing lower-income borrowers and increase investment in technology, leading to improved service quality. This improvement in service quality is more salient in counties with a higher percentage of minority populations.

Credit Risk, Regulatory Costs and Lending Discrimination in Efficient Residential Mortgage Markets

Significant differences in loan terms between demographically distinct groups of borrowers in the United States are often interpreted as evidence of systematic ethnic, racial or gender discrimination by lenders. The appearance and interpretation of such discrimination has long been a controversial issue in public policy and has significant implications for both the economic efficiency and equity of credit markets. Arising from concern for borrowers disadvantaged by such discrimination, the design and implementation of regulations preventing the disparate treatment of demographically distinct groups by lenders are generally considered to have enhanced the equality of access to credit. Unfortunately, existing research has not examined whether this gain in social equity comes at a cost in efficiency borne by all market participants. The reliance on adverse selection or moral hazard in current models of limited lending and credit rationing poses difficulties in empirical testing for the presence and magnitude of such costs. This paper offers a novel theoretical framework in which lending discrimination can endogenously arise in the presence of value-maximizing lenders competing in an economy with complete markets, common knowledge and arbitrage-free pricing. By avoiding the reliance of current models on the exogenous presence of adverse selection or moral hazard, this framework allows potential efficiency costs to beexamined in a market environment without an ex ante assumption of informational market failure. Owing to the presence of common knowledge among participants, we first show how equilibrium loan terms to borrowers in different demographic classes can diverge in such an efficient environment. We then apply the properties exhibited in market equilibria to measure the potential costs of misallocating credit risk owing to the type of regulations observed in actual credit markets.

The use of digital footprints in the US mortgage market

AbstractWe study the rise of digital footprint (DF) users in the U.S. residential mortgage market. The proportion of lenders that use a borrower's DF has witnessed remarkable growth from 6% in 2013 to 34% in 2018 in a short span – according to our analysis. We show that the use of DFs can significantly reduce a lender's overall risk and that the use of DFs can result in considerable societal benefits, by reducing the overall discriminatory forces. In sum, we provide evidence that the informational advantage associated with using a borrower's DF far outweighs that of existing traditional lending methods.

Consumer Choice in Residential Mortgage Market: An Islamic Mortgage Contract

This paper examines the Islamic mortgage contract of Diminishing Musharakah and its impact on consumer welfare, house purchase, and mortgage payments. We build both static and dynamic models to study a homeowner’s decision-making. We pay special attention to expectation formations and simulate the model to analyze both Islamic and Conventional mortgage holders’ responses to changes in income growth, house prices, and interest rates. Estimates of the model, using housing data set of U.S. economy (1990–2018), indicate that Diminishing Musharakah contract holders achieve 2.5 to 4% higher discounted utility under constant and declining learning expectations. The reducing balance feature of the Diminishing Musharakah contract provides relative protection to a consumer from adverse income shocks and high-interest rate environments. Simulation results suggest that under dynamic conditions, the Diminishing Mushrakah provides 3.4% lower mortgage cost per housing unit. It prevents consumers of average and low-risk appetite from relatively riskier housing decisions. We learn that consumer chooses a 2.5% smaller house size under Diminishing Musharakah. The model also examines consumers with vector autoregressive (VAR) based expectations. We find that homeowners with optimistic forecasts may achieve a higher utility in a conventional mortgage.

Analyzing the Causal Relationships Between Financial Crises and the Residential Mortgage Market

Subject. We consider the economic relations, arising in the process of the analysis of the financial and economic state of the housing (mortgage) loan market during crises. Objectives. The aim is to conduct a study within the practical concept of financial crises and the residential mortgage market, to identify cause-effect relationships. Methods. We apply analytical and expert methods, based on the analysis of residential mortgage market data and the activities of the Agency for Housing Mortgage Lending. Results. The study determines the segmented role of digitalization of the banking sector in the system of State programs intended to support the residential mortgage market. We reveal causal relationships between financial crises and the residential mortgage market on the basis of a factor analysis. Conclusions. During 2008 and 2014, the government regulation of the banking crisis was only through changing the level of the key rate. It resulted in an increase in interest rates and a decrease in demand for mortgage loans, as affordable mortgage interest rates still remain the main driver of mortgage lending for citizens. This scenario gives rise to a stagnation of the residential mortgage lending market and, consequently, a very long recovery period. In contrast to the scenario of 2020, where we see an active growth in mortgage lending against the background of the financial crisis, the reason was the implemented set of measures that triggered the growth and formed a safety cushion for the banking sector in the form of secured lending.

Is competition a cure for confusion? Evidence from the residential mortgage market

AbstractUsing the National Survey of Mortgage Originations, we document that borrowers who are more financially sophisticated (measured by their self‐reported understanding of the mortgage process) and more exposed to competition (measured by the number of lenders they considered) pay lower mortgage rate spreads. Yet, competition is not a substitute for sophistication: the benefits of competition accrue to sophisticates as well as to naïfs. Our results complement those from the literature detailing the limits of advice and education, and collectively they paint a pessimistic view about the prospects for simple interventions to close the mortgage rate gap between the informed and the naive.

Digitalization of the Residential Mortgage Market in Crisis Conditions: Main Factors and Drivers of Development

The industrialization of the residential mortgage market during the pandemic has undergone significant changes, like all sectors of the economy, including the banking system. During the transformation, a positive dynamics has been noted in the volume of loans, which contradicts the usual scenarios for the behavior of the mortgage market in the period of the unstable macroeconomic situation in recent years. The crises of 2008 and 2014 showed the vulnerability of the banking system and the market for residential mortgage market, the lack of timely measures to prevent drastic consequences for the banks and the state. At the moment, it is important to understand what drivers triggered the growth in the volume of residential mortgage. The research analyzed the reasons that had a key impact on the mortgage market and the banking sector during the covid-19 pandemic. As a result of the study, the main factors that help to draw up directions and digital algorithms for further development have been highlighted and classified.

Determinants of Price Discrimination and Switching Mortgage Provider in Times of Regulation and Digitalization

In this paper, we analyse the price discrimination and household switching in the residential mortgage market. Accessing a unique proprietary micro-data set from Norway, we examine the difference between the loan rate paid by current clients when receiving a competing offer from another bank and the best rate simultaneously being offered to new customers by the current bank. The results show that current clients pay around 20 basis points more than new customers are offered; however, this rate differential is kept in check by client switching. New regulations and digitalization that enhance transparency could reduce the rate differential, but the introduction of new banking products as well as the change in timing of the rate differentiation - from immediate upfront to gradually over time - may be used to preserve it.

Changing the Scope of GSE Loan Guarantees: Estimating Effects on Mortgage Pricing and Availability

Using a novel combination of mortgage datasets, we analyze the effects of two policy levers that influence the scope of Fannie Mae and Freddie Mac's (GSEs) involvement in the U.S. residential mortgage market. First, we find that small changes in mortgage guarantee fees charged by the GSEs were essentially fully passed through to consumers, with limited effects on mortgage demand. This implies that fee increases are primarily transfers from mortgage consumers to taxpayers while the GSEs remain in federal conservatorship. Second, the data suggest that marginally lowering maximum conforming loan size limits would cause most affected consumers to reduce their loan amounts to the new maximum. Our findings highlight the key role of GSE policy in mortgage availability and contrast the differing effects on consumers of two potential policy levers to reduce (or increase) the scope of GSE lending. Additional survey data indicate that borrowers' shopping behavior and incomplete information may also influence the effects of GSE policy changes.

Equality and Access to Credit: A Social Contract Framework

The problems governments face in regulating consumer finance fall into two categories: normative and cognitive. The normative problems have to do with the way that some governments, particularly those adhering to an American model of household finance, have financed social mobility and intergenerational welfare through debt, a tenuous and socially risky policy choice. Credit has a substantial social aspect to it in the United States, where the federal government has in some way engaged in subsidizing about 1/3 of consumer credit, particularly in the residential mortgage market, feeding into a substantial capital markets dimension through government-guaranteed securitization. Most Americans think they “choose” and “earn” their wealth only through their own efforts, but in fact a substantial institutional apparatus of government assistance supports wealth creation, particularly for higher income households, including substantial disguised subsidies supporting home mortgage credit. Access to credit in such a system becomes a social primary good in need of regulation to ensure compliance with equality principles appropriate to the society in question. Governments have poor records in regulating access to credit and in some cases enact law or support social structures going in the opposite direction, towards injustice, substantially impairing the life chances of persons and families in historically disadvantaged groups, compounding status and material inequality. No government has as yet developed appropriate policy tools to evaluate the effects of financial regulation on equality. Rather, most policies have historically entrenched and even promoted inequality. The cognitive problems have to do with the dilemma of trading off between paternalism and autonomy in consumer financial regulation. Disclosure approaches fail because they do not adequately take the cognitive limitations of persons into account. Debtors do not read or understand terms and conditions. Paternalism can fail because capital can freely exit a market and engage in regulatory arbitrage in seeking out the best returns. If credit is what in a Rawlsian framework can be understood as a social primary good in a society then all of these problems are all the more serious. The solutions to these twin normative-cognitive problems are in either taking the distributive justice of access to credit seriously or in decoupling debt from its role in producing social mobility when this cannot be done. Debt can be ill-suited for allocating basic means to a good life in a society. It converts collective duties of justice owed to individuals to private duties of contract owed by individuals, aggravating power and domination dynamics in a society and worsening inequality.

Effect of Bank Mergers on the Price and Availability of Mortgage Credit

We examine the effect of bank mergers on the price and availability of credit in the residential mortgage market. We find that, compared to non-acquiring banks in the same local market, acquiring banks that gain large market shares charge significantly higher interest rates but also lend larger amounts on non-agency mortgages in the years following the acquisition, and these effects vary significantly across prime, Alt-A and subprime loans. The corresponding effects for mortgages sold to Fannie Mae and Freddie Mac are economically insignificant. Acquiring banks also increase approval rates for conventional mortgage applications but this effect is weaker for low-income, black and Hispanic applicants; and decrease approval rates for FHA mortgage applications, especially for low-income and non-white applicants.

Short-term residential mortgage contracts in American economic history

Short-term contracts were a staple of the American residential mortgage market until the Great Depression, after which policymakers pushed for longer terms in order to eliminate refinancing risk. Using a first-of-its-kind data set on mortgages outstanding in 1930, this paper suggests that short-term contracts had remained popular until the Depression because of their appeal to a class of well-off sophisticated borrowers who were undeterred by refinancing risk, and who valued flexible amortization. In contrast, typical wage earners preferred longer terms in order to eliminate refinancing risk, even as they took on the burden of regular amortization payments.

Reinforcement learning and mortgage partial prepayment behavior

An agent can learn from previous experience to make decisions. Several important studies claim that reinforcement learning plays a key role in explaining the evolution of the individual learning process. This paper studies the likelihood of mortgage partial prepayments and the process through which mortgage borrowers learn from making partial prepayment decisions in the residential mortgage market in China. Learning dynamics are measured by studying the mortgage partial prepayment behavior of individual borrowers. A longitudinal discrete choice model of the choice of the mortgage payment is presented and estimated using a rich set of mortgage loan history data from a leading mortgage lender in China. The results indicate that path dependency and reinforcement learning arise whenever a borrower's “partial prepayment” decision depends not only on current-stage variables and his/her individual characteristics but also on the learning experience (both from himself/herself and others). Borrowers with more partial prepayment experience in previous stages have a higher probability of making the same decision in the future. Moreover, learning dynamics are not monotonic, and recent experience plays a larger role than distal experience in determining a partial prepayment decision.

From bombs to boons: changing views of risk and regulation in the pre-crisis OTC derivatives market

At the core of the 2008 financial crisis was a massive, un-publicly regulated market of complex financial products, which transmitted losses in the US residential mortgage market throughout the global financial system. How did the market for over-the-counter (OTC) derivatives grow so large and so risky with so little public supervision and regulation? At the heart of the matter, I contend, are changes in how both derivatives and risk have been understood as objects of governance. This article focuses on the decade preceding the passage of the 2000 Commodity Futures Modernization Act to demonstrate how competing and ultimately shifting understandings of both derivatives and financial risk put in place the conditions of possibility for the definitive deregulation of this market. Through a detailed interpretive analysis of regulatory documents, I show that changes in OTC derivatives regulation have been driven by changes in how regulators interpret derivatives themselves in a context of changing beliefs about risk and its management. Although regulators were acutely aware of OTC derivatives’ contribution to systemic risk as early as the early 1990s, they ultimately concluded that derivatives’ ability to serve as tools of risk management and generators of financial profits was consistent with their goal of promoting deep and liquid financial markets and thus took a decisively hands-off approach to regulation. The article concludes with a discussion of what shifts in interpretation and regulation of derivatives can tell us about the limits and potential for lasting post-crisis changes in financial governance.

Per-customer quantity limit and price discrimination: Evidence from the U.S. residential mortgage market

Theoretically, if firms face a regulatory per-customer quantity limit, they should have an incentive to discriminatively charge high-demand customers higher prices and make them just willing to buy a quantity equal to the limit. In the U.S. residential mortgage industry, mortgages with origination balances above the conforming loan limits cannot be guaranteed by government-sponsored enterprises, which make lenders face a per-customer quantity limit. This paper finds that borrowers bunching at the limit pay higher interest rates due to price discrimination. This study rules out the alternative explanation that those borrowers are of higher risk (lending cost) than other borrowers.

One More Case for Longer-Term Mortgages: Financial Stability

Longer-term mortgages would enhance both consumer choice and financial stability, but regulatory changes are needed to help them develop into a significant part of the Canadian residential mortgage market, says a new report from the C.D. Howe Institute. In “One More Case for Longer-Term Mortgages: Financial Stability,” author Michael K. Feldman notes that according to the Bank of Canada only 2 percent of all Canadian mortgages issued in 2018 were fixed-rate loans with terms of longer than five years. He further suggests that encouraging 10-year or longer mortgages would increase options for borrowers while adding more stability to the housing market.

Per-Customer Quantity Limit and Price Discrimination: Evidence from the U.S. Residential Mortgage Market

Theoretically, if firms face a regulatory per-customer quantity limit, they should have an incentive to discriminatively charge high-demand customers higher prices and make them just willing to buy a quantity equal to the limit. In the U.S. residential mortgage industry, mortgages with origination balances above the conforming loan limits cannot be guaranteed by Government-Sponsored Enterprises, which make lenders face a per-customer quantity limit. This paper finds that borrowers bunching at the limit pay higher interest rates due to price discrimination. This study rules out the alternative explanation that those borrowers are of higher risk (lending cost) than other borrowers.