The Performance of Low Income and Minority Mortgages

Abstract

This paper analyzes the performance of low income and minority mortgages (LIMMs) from a large sample of fixed rate conventional conforming mortgages. We test the extent to which exercise of prepayment and default options differ across groups. In particular, we test the extent to which options embedded in LIMMs are exercised more or less “ruthlessly.” We find that low-income borrowers are less likely to prepay when it is optimal, while Black and Hispanic borrowers prepay more slowly than other borrowers, regardless of whether the option is in or out of the money. We also find that after controlling for equity, credit history and some other variables, LIMMs default slightly more frequently and have about the same loss severity as other loans. Application of simple price models and rules of thumb suggest that for a downward sloping yield curve, the positive effect of differences in prepayment speed on price approximately cancels out the effect of the higher incidence of default.