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Study Says Counseling Reduces Delinquencies

June 18, 2001

Article By Chris de Reza, REFT Staff Reporter

A study recently released by Freddie Mac underscores the importance of the government-sponsored enterprises finding new ways to finance higher-risk mortgage loans, experts said.

The information was collected within the limits of Freddie’s data availability, meaning its system could easily churn out the 90-day delinquency numbers, an analyst said.

But one of the weaknesses of the report is that it shows what impact counseling has had on 90-day delinquencies, but not on defaults and other levels of delinquency, analysts said. In order to ascertain more detailed analysis, a more comprehensive study would have to be undertaken.

Nevertheless, the study is the first in which empirical evidence shows better payment performance by borrowers who undergo homeownership counseling. The report says that prepurchase homeownership counseling can improve 90-day delinquencies by as much as 34 percent, researchers said.

The study conducted by Abdighani Hirad and Peter Zorn, analyzed 40,000 Freddie Mac Affordable Gold mortgages originated between 1993 and 2000. Those loan products are typically low-downpayment mortgages that are designed to help increase homeownership rates for borrowers earning up to 100- percent of median income.

According to the study, of the three different types of homeownership counseling, “individual” counseling is the most successful with 34 percent reduction in 90-day delinquencies. Individual counseling comprises one-on-one attention for each applicant.

Classroom counseling was shown to reduce 90-day delinquencies by as much as 26 percent while home study participants saw a 21 percent reduction. Home study includes applicants taking their own initiative to maintain material, and re-viewing it online or in pamphlet form.

“I expect this study to launch an important dialogue about how to best use pre-purchase counseling to make homeownership more accessible to more families,” Zorn said. A draft of the study was first presented in November at a Harvard University symposium, but didn’t cause much stir until its release at the American Real Estate & Urban Economics Association midyear meeting in Washington May 31.

“It points out how critical it is when you have highly lever-aged loans that characterized the affordable market in helping the consumer know what they are getting into,” said Steve Hornburg, director of the Research Housing Institute of America (RIHA).

Hornburg also said the industry should start thinking of ways to ensure that loans with applicants that received prepurchase loan counseling are marked, so that the information is communicated to the secondary market. He said the industry should support efforts to better standardize and specialize prepurchase homeownership counseling based on the knowledge that it works.

“It is in the self-interest of lenders to have a clear under-standing on what type of counseling is being offered,” Hornburg said. “And to the extent the lender is holding the loans in port-folio or servicing, the evidence shows the loans tend to per-form better.”

The study brings new and important evidence to the table, said Stuart Gabriel, director, Lusk Center for Real Estate at University of Southern California (USC).

The caveats in the study concern data that is somewhat limited and the study does not explain whether or not prepurchase efforts affect or mitigate other measures of loan performance, such as loan losses in the event of default or loan prepayment patterns, according to Gabriel.

“I think the jury is still out on the loan performance implications of homebuyer counseling,” Gabriel said. “We need a fuller understanding of the magnitude of the risk mitigation associated with counseling—to ascertain whether the benefits are sufficient to be reflected in loan underwriting or pricing.”

Freddie Mac began requiring prepurchase counseling on Affordable Gold mortgages in 1993 to control the company’s potential credit risk exposure while it expanded the availability of affordable home financing opportunities for low- and moderate-income families.

The study claims to provide the first empirical evidence of the past 20 years that prepurchase homeownership counseling can significantly reduce the delinquency rates of borrowers. But the results of the study also point out that not all counseling programs are equally successful.

The report likely opened the door for more attention to re-fining counseling techniques.

“These empirical results are not unexpected; many in the counseling industry have argued for years that individual and classroom counseling are by far more effective tools,” according to the report. “But, if nothing else, it confirms the crucial role that counseling can play in expanding affordable homeownership opportunities for America’s families.”