Low-Income Homeownership: Examining the Unexamined Goal

Chapter 5. Prepurchase Homeownership Counseling: A Little Knowledge Is a Good Thing

For the past three decades homeownership counseling has been an integral part of affordable lending in the United States. Myriad benefits have been attributed to these programs. Its advocates believe, for example, that counseling better prepares borrowers to recognize and accept the responsibilities of owning a home. By helping to get households into homes they can afford, and afford to keep, homeownership counseling has been credited with stabilizing families and neighborhoods and reducing default risk for lenders. This study uses data on almost 40,000 mortgages originated under Freddie Mac’s Affordable Gold program to assess the claim that prepurchase homeownership counseling programs lower mortgage delinquency rates. We find statistical evidence that counseling does, in fact, mitigate credit risk. Borrowers who receive prepurchase homeownership counseling under the Affordable Gold program are, on average, 19 percent less likely to become ninety-day delinquent on their mortgages than borrowers with equivalent observable characteristics who do not receive counseling. 146 Prepurchase Homeownership Counseling: A Little Knowledge Is a Good Thing abdighani hirad and peter zorn 5 We are deeply indebted to Jim Carey for providing us with the opportunity to do this research and for sharing his knowledge about counseling, to Oliver Zeng for his outstanding work in developing the loan matching routine, and to Jim Berkovec for his econometric insights and consultation . The views expressed in this chapter are ours alone and do not necessarily represent those of Freddie Mac or its Board of Directors. file03 ch4-6 pp105-200.qxd 7/5/2002 2:16 PM Page 146 We also find significant variation in the effectiveness of classroom, homestudy , individual, and telephone counseling. Our data clearly indicate that borrowers who receive individual counseling have the greatest mitigation in credit risk. All things equal, the ninety-day delinquency rate of borrowers who received individual counseling was reduced by 34 percent, an outcome that is superior and statistically different from that obtained by either home-study or telephone counseling. Classroom and home-study counseling reduced delinquency rates at 26 percent and 21 percent, respectively, and were superior to telephone counseling, which had no statistically significant impact on borrower delinquency. Affordable Gold borrowers receive counseling from a variety of sources, including government agencies, lenders, mortgage insurers, and nonprofit organizations . Our basic analysis, however, offers no statistical evidence that any provider administers counseling in a manner that is either more or less effective in reducing credit risk. Borrowers who received counseling from nonprofit organizations and lenders did, on average, have lower ninety-day delinquency rates than borrowers counseled by other providers. This outcome, though, primarily appears to reflect the more effective mix of counseling these groups provide. Our data were not collected as part of a controlled experiment. We therefore also consider the possibility that the effects we attribute to counseling are in fact due to unobserved characteristics associated with borrowers’ assignment or selection into counseling programs. The results of statistical tests strongly reject the hypothesis that counseling’s estimated effectiveness is entirely due to such unobserved characteristics. Moreover, our best estimate after accounting for these unobserved characteristics is that counseling is more rather than less effective. We also statistically confirm the previously identified differences in effectiveness of alternative counseling programs, as well as differences among providers. We are unable, however, to statistically confirm that individual and home-study counseling ’s effectiveness is not due to borrower assignment or selection. This study is the first to provide significant empirical evidence that prepurchase homeownership counseling can effectively reduce borrowers’ delinquency rates.1 Notwithstanding some unresolved issues, any evidence that homeownership counseling effectively mitigates risk is welcome news. Affordable lending programs historically have pushed the limits of underwriting in an effort to offer the benefits of homeownership to the greatest number of families. Prepurchase counseling by no means eliminates the greater credit risk of these programs— even with counseling, affordable lending loans likely will be among the riskiest of mortgages originated by most prime lenders. The empirical evidence presented in this chapter does demonstrate, however, that prepurchase homeownership counprepurchase homeownership counseling 147 1. The empirical studies that have been conducted are twenty or more years old and are generally viewed as unconvincing. A review and critique of existing statistical studies is provided in Mallach (2001) and Quercia and Wachter (1996). file03 ch4-6 pp105-200.qxd 7/5/2002 2:16 PM Page 147 seling can increase the success of affordable lending programs by helping...