Consumer Law

Behaviorism and Mortgage Workouts

By Alan White

By Alan White

Some useful applications of behavioral economics have emerged from efforts to deleverage American homeowners through mortgage renegotiations.  Servicers have complained that they have great difficulty persuading borrowers to respond when they offer help and solicit information, like current income verifications, in order to rewrite loan terms.  The FDIC/Indymac program took the simple additional step of calculating a new (lower) monthly payment that could result from a successful application for modification, and included that vital bit of information in its mailing to homeowners.  It's the same behavioral device as a pre-approved credit card.  Not surprisingly, borrower response rates improved.  According to a story in Friday's L.A. Times, Indymac got a 73% response rate from borrowers who had previously called, and to whom it sent a proposed modification with a prepaid, return FedEx envelope.  73% is an unheard-of response rate in this context.

The state regulators' September data release reports that there remains a large gap between homeowner applications for workouts and completed workout deals, on the order of two or three to one.  Why would a homeowners start the process and not see it through?  Or on the other hand, why would servicers spend time and effort beginning a workout application but not see it through?  From the standpoint of rational choice theory, both parties would have much to gain and little to lose, assuming that the servicer has done some initial screening (foreclosure value prospects not good, homeowner still in the home, homeowner believes they have income to service modified loan.)  Remember, we are talking about applications that remain undecided, not applications that are rejected. 

The large drop-off in foreclosure workout applications may in part be due to inadequate staffing and resources on the servicer side.  But it could also be due to channel factors, i.e. exactly what affirmative steps the borrower must take, and how and when they receive some positive encouragement about the process.

There are, of course, some possible rational choice explanations for low borrower response rates:  perhaps many borrowers who don't call or follow through realize their income is just too low.  They may have found a better, cheaper housing alternative, or have been involved in a questionable or fraudulent mortgage application, as is the case with investors who misrepresented themselves as owner-occupants.  Nevertheless, the large difference in response rates produced by very simple servicer strategies reinforces my view that more foreclosures can be prevented.

Full post as published by CL&P Blog on November 02, 2008 (boomark / email).