Stochastic Modeling of Federal Housing Administration Home Equity Conversion Mortgages with Low-Cost Refinancing

Federal Housing Administration-insured reverse mortgages, known as Home Equity Conversion Mortgages (HECMs), did not originally have a provision for low-cost refinancing. If a borrower's house value increased faster than expected, the borrower could not tap that additional equity without terminating the first loan and originating a new HECM loan with full closing costs. We test several low-cost refinancing options using a stochastic simulation model that allows interest rates and house prices to vary in historically accurate patterns. Low-cost refinancing decreases the net value of the fund by 54% to $98.5 million, but it remains positive in 80% of the trials. Copyright 2004 by the American Real Estate and Urban Economics Association

The Conditional Probability of Foreclosure: An Empirical Analysis of Conventional Mortgage Loan Defaults

This paper analyzes the factors affecting the conditional probability that defaulted residential mortgage loans will foreclose. We analyze a large national sample of conventional loans, which have been in default at least once during the 1988 to 1994 period. For such loans, lenders and borrowers either individually or jointly make choices which lead to the following outcomes: (1) resumption of payments, (2) termination by prepayment, or (3) foreclosure. Our estimates of a logit model indicate that termination option values and local area economic and housing market conditions affect default resolution probabilities. Perhaps more importantly, simulations using the logit model indicate that the efficiency of the default resolution process may be substantially improved by legal and regulatory reforms. Copyright 2004 by the American Real Estate and Urban Economics Association

Economic Depreciation of Residential Real Estate: Microlevel Space and Time Analysis

Three elements in the study of real estate depreciation that warrant further consideration are uncovered: the spatial variation of depreciation on a micro scale, the variability of depreciation within a single market across time and the recognition of land value as an influence in modeling real property prices. Taken together, these three dimensions provide an opportunity to further expand the understanding of residential economic depreciation while enhancing the predictive power of real estate market models. The analytical results, utilizing a land-value-adjusted hedonic model, indicate that both the intramarket location and the year in which the property sold have significant impacts on the observed rate of economic depreciation. Such information is vitally important to policymakers and others interested in accurate modeling of real estate markets. Copyright 2004 by the American Real Estate and Urban Economics Association

Equity Dilution: An Alternative Perspective on Mortgage Default

Empirical research on mortgage default in the single-family market has focused on the value of the borrower's put option using house price indices to estimate contemporaneous loan-to-value ratio or the probability of negative equity. But since the borrower possesses the option to increase leverage by taking on additional debt secured by junior liens subsequent to loan origination (a phenomenon termed here equity dilution), even a perfect house price adjustment cannot be expected to accurately measure changes in borrower equity over time. Since junior liens are generally unobservable to senior debt holders, proxies are required in empirical applications. This paper employs an independent estimate of junior lien probability developed from the 1998 Survey of Consumer Finances combined with loan level mortgage performance data to examine the role junior liens play in increasing default risk. Copyright 2004 by the American Real Estate and Urban Economics Association

The Effect of Conforming Loan Status on Mortgage Yield Spreads: A Loan Level Analysis

The magnitude of the effect of government-sponsored enterprise purchases on primary mortgage market rates has been a difficult research question with differing data and competing methodologies producing varying results. Here we present a new approach using loan level data and controlling for credit risk differentials between conforming and nonconforming loans. Our method also addresses econometric problems of endogeneity and sample selection bias. We find that conforming loans have yield spreads about 5.5% lower compared to other loans on a risk-adjusted basis. This is lower than previous estimates appearing in the literature. Copyright 2004 by the American Real Estate and Urban Economics Association