Credit Risk and the Provision of Mortgages to Lower-Income and Minority Homebuyers
Canner, Glenn B., Passmore, Wayne, Federal Reserve Bulletin
Glenn B. Canner and Wayne Passmore, of the Board's Division of Research and Statistics, wrote this article. Mark A. Peirce, of the Division of Research and Statistics, and Gary G. Myers and Keith Phipps, of the Division of Information Resources Management, provided assistance.
A core function of mortgage lenders, as of other financial businesses, is the measurement, acceptance, and management of risk. The key risk for mortgage lenders is credit risk, which arises from the possibility that borrowers may fail to pay their loan obligations as scheduled. The institution that bears the credit risk in mortgage lending is critical because, without such a participant, a mortgage cannot be made.
The credit risk associated with a mortgage is accommodated through a variety of financial arrangements and institutions. Some institutions, such as mortgage companies, mainly originate loans for sale to third parties. To facilitate this process, mortgage companies often transfer to a mortgage insurer much or all of the credit risk associated with holding the loans, thereby reducing the loss the loan purchaser would suffer in the event of default by a borrower. Other institutions, mainly depositories, keep in their portfolios many of the loans they originate. Like a purchaser of mortgages, however, a depository institution that holds a mortgage may not bear the full risk of default associated with it but may instead share the risk with a mortgage insurer.
Although; a considerable amount of information is available about which institutions hold mortgages, less is known about which bear the credit risk. To assess the distribution of mortgage credit risk, we have combined data collected in conjunction with the Home Mortgage Disclosure Act (HMDA) with data submitted by private mortgage insurers about the mortgages they insure. With this unique database, we have obtained a rough gauge of which institutions bear the credit risk of mortgages. In addition, because of the strong public interest in the provision of credit to lower-income and minority homebuyers, we have measured the distribution of credit risk across institutions by the income and race or ethnic group of the borrower and by characteristics of the neighborhoods in which mortgage boffowers reside.(1)
and Mitigation of Credit Risk
When scheduled payments on a mortgage are not made, a lender typically does not know whether the borrower intends to delay payments only temporarily or to stop them altogether. The borrower is considered "delinquent," but the lender's initial expectation is that the payments will resume. If scheduled payments continue to be missed, the lender may perceive that the borrower does not intend, or is unable, to repay the loan fully.
A lender may take actions against a delinquent borrower by imposing late fees and, in cases of numerous missed payments, by foreclosing on the mortgage and forcing a sale of the property securing the loan. But foreclosure is ordinarily quite costly to the lender, who can expect to incur a variety of expenses during the process: interest accrued from the time of delinquency through foreclosure, legal expenses, costs to maintain the property, expenses associated with the sale of the property, and the loss that arises if the foreclosed property sells for less than the outstanding balance on the loan. A sale for more than the outstanding balance will offset some or all of the lender's expenses, but generally a substantial portion of the costs are not recovered by the sale of the property.
Because foreclosure is costly, a lender often chooses to work with the borrower to acquire payments on the delinquent loan. For instance, a lender may provide credit counseling, establish a repayment plan to bring the loan payments back on schedule, or renegotiate the original terms of the loan. Working with delinquent borrowers to avoid default, however, can also be costly to the lender, who must provide the resources for these activities. …