New report from MBA looks at ways to alleviate market pressures from mortgage defaults

A new research report from the Mortgage Bankers Association (MBA) examines models, standards, and policies that would help alleviate market pressures resulting from high levels of mortgage defaults.

The report — Mortgage Design, Underwriting, and Interventions: Promoting Sustainable Homeownership — 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 to better handle 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. It also examines how sustainable homeownership involves addressing the varying needs of borrowers to minimize 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,” Joseph Tracy, a distinguished fellow at Purdue University and former senior Federal Reserve advisor, said. “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.”

Among the key findings, the paper revealed the following:

• 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.

It also said that the aim when intervening with a distressed borrower is not to limit foreclosures, but rather to minimize the loan’s expected loss. Further, it said that 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.

In addition, it revealed two key strategies for helping distressed borrowers — mitigate any cash-flow constraints and deleverage the borrower. Finally, it found that improving the robustness of housing finance and sustainable homeownership requires examining mortgage design, underwriting, and intervention policies for addressing stressed mortgage borrowers.

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

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