Building Assets, Building Credit: Creating Wealth in Low-Income Communities

Innovative Servicing Technology: Smart Enough to Keep People in Their Houses?

348 Innovative Servicing Technology: Smart Enough to Keep People in Their Houses? amy crews cutts and richard k. green 14 The advent of automated credit-scoring evaluation tools in the mid-1990s has led the mortgage industry through a major technological revolution. The impact of credit scoring and automated underwriting in the loan origination process and on homeownership has received much attention (see, for example , Avery and others, 2000; Straka, 2000; Gates, Perry, and Zorn, 2002; and Gates, Waldron, and Zorn, 2003); innovations in loan servicing have received relatively little (for a rare exception, see Stegman, Quercia, and Davis, 2003). Yet it is the case (as shown in figure 14-1) that foreclosure rates have stayed below their 1998 levels throughout the 2001 recession and subsequent two years of job-loss recovery. At the same time, the mortgage servicing industry has undergone dramatic changes, emphasizing the use of credit-scoring tools and home-retention workouts to try and keep people in their homes.1 This chapter focuses on the impact of the servicing of delinquent loans on the likelihood of home loss through foreclosure. We believe this is the first empirical study to focus on the issue. 1. According to the Mortgage Bankers Association National Delinquency Survey, quarterly foreclosure rates in 1998 varied between 0.58 and 0.69 percent. The peak foreclosure rate during the 2001 recession and subsequent recovery period (as of June 2003) was 0.56 percent—over that same time there were nine consecutive quarters of losses in nonfarm payroll employment, totaling 2.6 million jobs. During the 1990–91 recession and recovery period, foreclosure rates peaked at 0.83 percent, with 1.5 million jobs lost over four quarters. 20 7409-5 ch14.qxd 7/7/2005 10:23 PM Page 348 innovative servicing technology 349 The economics literature on mortgage defaults has long focused on two borrower options: payment of the mortgage obligation, or default (generally interpreted as the borrower handing over the keys to the property in exchange for cancellation of the mortgage obligation—the borrower exercises the put option). Often, default and foreclosure are used interchangeably to imply the borrowers lose their homes. Recently, the literature has started to consider default and foreclosure separately from delinquency, but the papers are limited in scope regarding the variety of options that borrowers hold both in delinquency and foreclosure, and none are fully modeled empirical studies. LaCour-Little (2000) provides an excellent history of the evolution of technology in the mortgage industry. His focus is primarily on origination and data management, however, and provides little on the innovations in mortgage servicing . We extend the work of LaCour-Little (2000) by documenting the innovations in mortgage loan servicing and loss mitigation. We focus in particular on Freddie Mac’s innovations in these areas, and examine whether two programs in particular have helped stave off foreclosure and, as such, have kept people in their homes. We begin by developing a taxonomy of servicing, default, and workout options, then review the default literature as it pertains to the innovations in loan servicing and loss mitigation. We follow with a description of technological Figure 14-1. Foreclosure Rates of Prime Conventional Loans Compared to Employment, 1998–99 –500 0 500 1,000 1,500 2,000 2,500 3,000 3,500 0.2 0.4 0.6 0.8 2003 2001 1999 1997 1995 1993 1991 1989 1987 1985 1983 1981 Foreclosure rate (percent inventory at end of quarter) Employment (thousands on nonfarm payrolls) Recession Foreclosure rates Employment Sources: Mortgage Bankers Association of America, Freddie Mac, National Bureau of Economic Research, Bureau of Labor Statistics. 20 7409-5 ch14.qxd 7/7/2005 10:23 PM Page 349 innovations in problem loan servicing, including Freddie Mac’s Early Indicator ® tool and workout programs, and provide some descriptive statistics that suggest they have been successful in mitigating home loss. We close with an empirical model of foreclosure conditional on delinquency that attempts to quantify the extent to which a workout program can prevent foreclosure, with attention to U.S. Department of Housing and Urban Development–defined low- and moderate-income and underserved borrowers. Taxonomy of Servicing and Default Before engaging in a discussion of the implications of servicing innovations and economic models of mortgage default, it seems sensible to start with a discussion of what loan servicing entails and what constitutes borrower default. Servicing Mortgage servicing, at...