Academic journal article Cityscape

Sustaining Homeownership after Delinquency: The Effectiveness of Loan Modifications by Race and Ethnicity

Academic journal article Cityscape

Sustaining Homeownership after Delinquency: The Effectiveness of Loan Modifications by Race and Ethnicity

Article excerpt

Introduction

The recent foreclosure crisis and the resulting erosion of family wealth and neighborhood stability have raised critical questions about the policies and programs that are needed to sustain homeownership. While policy has focused on consumer protections in the mortgage lending market and the terms by which borrowers access credit, an equally important focus is what happens after loan origination. Mortgage-servicing, collections, and loss-mitigation practices should be central to the dialogue around how to promote homeownership while reducing the costs of foreclosures on borrowers, communities, and the overall U.S. economy.

Compared with the vast research and literature about mortgage loan application and origination outcomes, however, mortgage-servicing practices have received fairly little research attention. One barrier to studying loan servicing and loss-mitigation practices is that mortgage modifications are largely at the discretion of loan servicing firms, and modification terms and outcomes are not as systematically transparent as loan application approvals and denials. This lack of information stands in stark contrast to the highly transparent process used to track mortgage loan application approvals and denials under the Home Mortgage Disclosure Act (HMDA). In addition, the process of modifying a loan is highly individualized, time consuming, and "more art than science."1 As a result, consumer advocates have raised the concern that the loan modification process could unfairly burden historically underserved borrowers-especially those who lack experience and knowledge of dealing with a lending institution. For example, borrowers who do not speak English or who may distrust banking institutions may fail to pursue a loan modification, or they may not be able to negotiate the best modification terms. Race or perceived race could also serve as a proxy that servicers use for decisionmaking on modifications, especially if these borrowers are deemed less sophisticated, more time consuming, and, therefore, more costly to serve. Understanding whether modification outcomes are different by race or ethnicity is especially important given the disparate impact of the foreclosure crisis on Black and Hispanic households (Bocian et al., 2011) and the role that homeownership plays in the racial wealth gap (Oliver and Shapiro, 2006).

In this article, we use a unique dataset that merges national data on the loan performance of sub prime home mortgages from more than 100 servicers with data on borrower demographics reported as part of HMDA. With these data, we are able to examine national trends in loan modification types by borrowers' race and ethnicity and to assess the subsequent outcomes of those modified loans for a large sample of subprime loans. Previous research to date has not found racial disparities in the incidence of loan modifications (Been et al., 2013; Collins and Reid, 2010), but these studies have not examined the changes in loan terms by race, nor have they assessed whether differences in modification terms lead to different rates of redefault after.

Our findings suggest that, conditional on a loan having modified terms, there are no significant racial or ethnic differences in the types of modifications that borrowers receive. In fact, we find that controlling for a range of borrower, loan, and housing market characteristics, minorities are equally likely to receive a loan modification that involves lowered interest rates or principal balances. When we examine the amount of change in monthly payments, we find that Black, Hispanic, and Asian borrowers are all more likely to receive a slightly larger reduction than White borrowers, although the amount is small. In terms of the effectiveness of loan modifications, we find that modifications reduce the likelihood of subsequent redefault and foreclosure, and that the terms of the modification influence its effectiveness, even after controlling for a wide range of variables. …

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