Mortgage Refinances, Streamlines and Adverse Selection

The Dice Center for Research in Financial Economics Working Paper 98-5

25 Pages Posted: 26 Oct 1998

See all articles by David M. Brickman

David M. Brickman

Federal Home Loan Mortgage Corporation (FHLMC)

Patric H. Hendershott

University of Aberdeen - Centre for Property Research; National Bureau of Economic Research (NBER)

Abstract

The call and default options of mortgage borrowers interact in ways that must be accounted for in both the pricing of mortgages (or equivalently the setting of mortgage coupon rates relative to Treasury coupons), the pricing of default insurance, and empirical explanations of mortgage terminations. The call option of FHA borrowers was considerably enhanced in the early 1980s with a significant reduction in the cost of streamline refinancing (limited documentation, no required appraisal, etc.). This enhancement reduced the value of the default option of FHA borrowers.

We provide evidence of the negative impact of regular (nonstreamline) refinancing on the average quality of FHA?s surviving business. We demonstrate this adverse selection both informally and econometrically. We also argue that FHA?s streamline refinance program has likely reduced the level of adverse selection in the FHA portfolio and provide quantitative estimates of the potential gain from this reduction.

Suggested Citation

Brickman, David M. and Hendershott, Patric H., Mortgage Refinances, Streamlines and Adverse Selection. The Dice Center for Research in Financial Economics Working Paper 98-5, Available at SSRN: https://ssrn.com/abstract=136694 or http://dx.doi.org/10.2139/ssrn.136694

David M. Brickman (Contact Author)

Federal Home Loan Mortgage Corporation (FHLMC) ( email )

8200 Jones Branch Road
Mailstop 486
McLean, VA 22101
United States
(703) 903-2343 (Phone)
(703) 903-3736 (Fax)

Patric H. Hendershott

University of Aberdeen - Centre for Property Research ( email )

Aberdeen AB24 2UF
Scotland

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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