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The Paradox of Judicial Foreclosure: Collateral Value Uncertainty and Mortgage Rates

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Abstract

Using a sample of 26,892 rate quotes on home purchase loan applications, the current paper investigates interstate variation in residential mortgage interest rates. More specifically, we find posted rate quotes by lenders are directly related to measures of foreclosure process risk including the length of time required to complete foreclosure proceedings within a jurisdiction and the presence (and length) of statutory redemption periods. Mortgage rates are also found to be contingent upon differential underwriting fees and conditions, housing appreciation and volatility measures, and the competitive nature of the economic marketplace in which each lender operates. In contrast to the previous literature, we find the judicial foreclosure process requirements exert little to no impact on observable mortgage interest rate quotes after controlling for these additional dimensions of risk.

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Notes

  1. See, for example, Stiglitz and Weiss (1981) for a theoretical discussion of credit rationing versus risk-based pricing.

  2. For a comprehensive survey of the early work in this area, see Quercia and Stegman (1992). Additional studies of note in this area include, but are not limited to: Von Furstenberg (1969), Campbell and Dietrich (1983), Hendershottt and Van Order (1987), Schwartz and Torous (1989, 1992), Berkovec et al. (1994), Munnell et al. (1996), Deng (1997), Avery et al. (2000), and Deng et al. (2000).

  3. See Nichols et al. (2005) for an examination of the user costs of home ownership.

  4. See, for example, Blackwell and Winters (2000).

  5. Alternatively, large regional or national banks may possess reputational capital advantages which allow them to charge higher rates than their lesser known competitors. See Carter and Manaster (1990) for an extended discussion of the importance of reputational capital effects in security markets.

  6. See, for example, Twedt (1965), Lambert (1975), Brenner and Brenner (1982), Schindler and Kirby (1997), and Bizer and Schindler (2005).

  7. Additional evidence of psychological pricing activity in real estate markets may be found in Allen and Dare (2004a, b) and Salter et al. (2007).

  8. Within the current sample, only 712 of 26,892 rate quote observations (or 2.65 %) occur at intervals other than 1/8th of a percentage point.

  9. More precisely, the rate quotes obtained for this sample were originally posted between April 8 and April 22, 2011, with each quote being an individual lender’s most recent listing for a specific city as of April 22, 2011.

  10. While these effective rates serve as the dependent variable throughout the empirical analysis which follows, our results are robust to the use of the actual posted rate quote, the lender reported annual percentage rate (APR), or this implied effective rate computed using an assumed 7 year mortgage life.

  11. We recognize this is a potential over simplification of idiosyncratic foreclosure practices employed across states. For example, many states allow both power of sale and judicial processes, with lenders frequently entitled to seek more immediate recourse via selecting power of sale procedures at the potential cost of limiting their ability to pursue large deficiencies which may only be obtainable through more formalized proceedings.

  12. These jurisdictions include Boise, ID; Carson City, NV; Conway, SC; Lake Tahoe, CA; Lakeland, FL; Myrtle Beach, SC; Wilmington, NC; Winter Haven, FL; and Yuma, AZ.

  13. Similarly, lenders may simply charge higher rates in such high cost areas to offset their normal cost of doing business associated with non-strategic default occurrences.

  14. Subprime market share data estimates by state obtained from: http://money.cnn.com/magazines/fortune/storysupplement/subprime_statebystate/; accessed 9/9/2010.

  15. The nine states without (ordinary wage and salary) income tax requirements for 2011 were Alaska, Florida, New Hampshire, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming. The highest marginal rates were found in Oregon (9.0 %), Iowa (8.98 %), Maine (8.5 %), Washington D.C. (8.5 %), and California (8.0 %). For extensive discussion and details on individual state level tax rates and provisions, see: http://www.taxfoundation.org/; accessed 12/19/2012.

  16. Throughout the empirical analyses which follow, we note that Bankrate quotes (i.e., our sample observations) are drawn from the automated underwriting systems of various lenders. To the extent lenders providing mortgage rate quotations across alternative geographic locations employ a single automated platform, our observations may not be independent. As a result, the statistical significance of our findings could be artificially inflated. Recognizing this concern, we make a concerted effort throughout the discussion of our analyses to emphasize the economic, as well as statistical, import of our findings.

  17. While our redemption period length variable is statistically significant, the economic magnitude of this association is very small, rendering it essentially inconsequential as a material determinant of posted mortgage rate quotes. Alternative model specifications using a simple binary indicator variable identifying the presence or absence of any statutory redemption period provide similar results to those reported, with our indicator variable for the presence of a redemption period exhibiting statistical, but not economic, significance.

  18. In estimating acceptance rates, we ignore LAR records corresponding to loan purchases and preapprovals, as well as information pertaining to loan applications which were withdrawn by the prospective borrower or closed by the institution without a formal credit extension decision being reached. Under this framework, over 80 % of mortgage loan applications were accepted and resulted in the extension of credit.

  19. The authors attribute this latter result to the existence of either regulatory capital arbitrage, or reputation building, on the part of lending institutions.

  20. From September 7, 1996 until October 1, 2013, Freddie Mac required a delivery fee on mortgages secured by condominium units in California. However, this fee was in response to perceived earthquake risk and uncertainty surrounding the efficacy of earthquake insurance requirements. Foreclosure process risk was not a material consideration in the adoption of this fee.

  21. Given that judicial foreclosure jurisdictions are associated with longer disposition times, this is consistent with the strategic default motivation of being able to live in the home “mortgage payment free” for an extended period.

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Authors and Affiliations

  1. Rawls College of Business, Texas Tech University, Lubbock, TX, USA

    David M. Harrison

  2. K. Dane Brooksher Endowed Chair of Real Estate and Finance, Mason School of Business, The College of William and Mary, Williamsburg, VA, USA

    Michael J. Seiler

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  1. David M. Harrison
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Correspondence to David M. Harrison.

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Harrison, D.M., Seiler, M.J. The Paradox of Judicial Foreclosure: Collateral Value Uncertainty and Mortgage Rates. J Real Estate Finan Econ 50, 377–411 (2015). https://doi.org/10.1007/s11146-014-9467-y

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