Impacts of Competing Risks of Mortgage Termination in Underserved Areas

Author: Duan Zhuang

Dissertation School: University of Southern California

Abstract:

Owning a home is an important aspect of the American dream. However, partly due to inequalities in mortgage lending, not all borrowers can enjoy equal access to the benefits of homeownership. After decades of effort in enforcement of anti-redlining and anti-discrimination laws, minorities are still less likely than Whites to be approved for home mortgage loans. Certain inner-city neighborhoods still cannot obtain the mortgage credit necessary to achieve homeownership.

It has been 10 years since the Boston Federal Reserve Board's study of discrimination in mortgage lending. This proposed study seeks to build upon that important literature. In so doing, it aims to provide empirical evidence to help mortgage lenders reevaluate the risks in loan performances so as to enhance homeownership opportunity and improve the loan profitability.

Pioneered by Deng and Gabriel (2002), an option-based hazard model was developed to simultaneously assess the competing risks of FHA mortgage default and prepayment. The analysis seeks to assess the differential default and prepayment probabilities among higher credit risk FHA mortgage borrowers. The results of the study show that although mortgage loans to lower-income and higher credit risk borrowers are characterized by high default probabilities, those risks may be mitigated by their lower prepayment possibilities. Owing to difficulties in borrower access to mortgage credit, problems of mortgage qualification, limited borrower knowledge of mortgage refinance options, or damped residential mobility, loans to higher credit risk borrowers may prepay more slowly. Because the prepayment risk premium is substantial, the differentially slower prepayment speeds of loans to higher risk borrowers may have important implications for loan profitability and for efforts to expand homeownership among those groups.

The Deng-Gabriel (2002) study provides a solid framework for assessing the impacts of competing risks of mortgage terminations. However, the differential performance of between the FHA-insured mortgage loans in underserved areas and local markets overall were not well explored in that analysis. Following the competing risk framework, the proposed research will compare the performance of the loans in underserved area to the market performance of the loans in general, particularly focusing on prepayment and default probabilities of the loans in the underserved urban areas.

The study is unique in terms of both its methodology and policy implications. The results of the study can provide policymakers more powerful insights of mortgage performance in underserved areas hence to promote HUD policy regarding equal opportunity to access housing finance and to help residents living in the underserved areas become homeowners.

Ideally, this research will focus on the nationwide FHA loan performance, using a large random sample of FHA-insured home purchase loans originated during a five-year period in the 1990s. Alternatively, it is also plausible to focus on the Los Angeles Consolidated Metropolitan Statistical Area (CMSA), using FHA mortgage transaction data from the California Market Data Cooperative, Inc. (CMDC).

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