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

By Phillips, Richard A.; VanderHoff, James H. | Real Estate Economics, Winter 2004 | Go to article overview

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


Phillips, Richard A., VanderHoff, James H., Real Estate Economics


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.

**********

Homeownership has been associated with benefits to individuals, families and society; it is the cornerstone of the "American dream." The value that individuals place on their homes is indicated by the low default rates on residential mortgage loans. (1) Nonetheless, a small percentage of homeowners default on their mortgages and relinquish their homes to lenders by allowing foreclosure. Although small as a percentage of all mortgage originations, defaults (and subsequent foreclosures) are large in absolute numbers, producing substantial losses to lenders/investors and higher housing finance costs to consumers. This paper analyzes factors that affect the likelihood that defaults will ultimately foreclose and provides information on foreclosure probabilities that will allow lenders/investors and public policy analysts to implement strategies to improve the efficiency of default resolution and reduce costs to consumers.

The analysis of mortgage decisions starts from the assumption that mortgagors possess an implicit option to terminate loans and relinquish their homes by defaulting and allowing foreclosure. Unanticipated (denoted "trigger") events may induce default, but such events do not necessarily culminate in foreclosure since loans may also be terminated by prepayment. However, exercising the prepayment option in the face of financial distress presupposes a positive equity position and a relatively liquid housing asset. Most theoretical and empirical research analyzes financially motivated or option-induced terminations, either by default or prepayment. While trigger events force households to breach financial commitments, in the option framework default is based on wealth maximization irrespective of trigger events. Default is predicted when equity is less than the present value of mortgage payments: The default option is "in the money." The implicit assumption of these models is that once initiated, borrowers do not rescind default option exercise. The strategy of so-called "ruthless" defaulters is to allow foreclosure and shift losses to lenders. Numerous researchers have used variations of option-based models to estimate either prepayment or default (or both) termination probabilities, and empirical results generally support the predictions of these models. (2)

A limitation of the option models is that defaults are defined as foreclosures. This assumption eliminates the consideration of an additional option for borrowers: the temporary suspension of payments (a short term "loan") to weather financial storms possibly caused by trigger events. Our estimates and mortgage market facts suggest that this option is important. (3) For example, only a minority (about 20% in recent years) of defaults result in foreclosure. Defaulted loans in which payments are resumed are "cured" while other defaults are terminated by prepayment prior to foreclosure. Determinants of resolutions cannot readily be evaluated in the standard option framework. Recent models developed by Ambrose and Capone (1996, 1998, 2000), Ambrose and Buttimer (2000) and Ambrose, Buttimer and Capone (1997) address this limitation by modeling default as a process in which borrowers and lenders reevaluate the decision to allow foreclosure. …

The rest of this article is only available to active members of Questia

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Default project is now your active project.
Project items
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Buy instant access to cite pages or passages in MLA 8, MLA 7, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

(Einhorn 25)

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Note: primary sources have slightly different requirements for citation. Please see these guidelines for more information.

Cited article

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

Settings

Typeface
Text size Smaller Larger Reset View mode
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Help
Full screen
Items saved from this article
  • Highlights & Notes
  • Citations
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

matching results for page

    Questia reader help

    How to highlight and cite specific passages

    1. Click or tap the first word you want to select.
    2. Click or tap the last word you want to select, and you’ll see everything in between get selected.
    3. You’ll then get a menu of options like creating a highlight or a citation from that passage of text.

    OK, got it!

    Cited passage

    Style
    Citations are available only to our active members.
    Buy instant access to cite pages or passages in MLA 8, MLA 7, APA and Chicago citation styles.

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

    1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

    Cited passage

    Thanks for trying Questia!

    Please continue trying out our research tools, but please note, full functionality is available only to our active members.

    Your work will be lost once you leave this Web page.

    Buy instant access to save your work.

    Already a member? Log in now.

    Search by... Author
    Show... All Results Primary Sources Peer-reviewed

    Oops!

    An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.