The purpose of this book is to provide an overview of current consumer
finance research from multidisciplinary perspectives. The chapters are contributed by leading researchers in consumer finance.

/pdf/handbook-of-consumer-finance-research-3jc86ex5bk.pdf

Handbook of Consumer Finance Research

This article studies optimal mortgage design in a continuous-time setting with volatile and privately observable income, costly foreclosure, and a stochastic market interest rate. We show that the features of the optimal mortgage are consistent with an option adjustable-rate mortgage (option ARM). Under the optimal contract, the borrower is given discretion of how much to repay until his balance reaches a certain limit. The default rates and interest rate payment on the mortgage correlate positively with the market interest rate. Gains from using the optimal contract relative to simpler mortgages are the biggest for those who face more income variability, buy pricey houses given their income level, or make little or no down payment. Our model thus may help to explain a high concentration of option ARMs among riskier borrowers. (JEL G20, G21, G33)

Optimal Mortgage Design

This paper studies optimal mortgage design in a continuous time setting with volatile and privately observable income, costly foreclosure, and a stochastic market interest rate. We show that the features of the optimal mortgage are consistent with an option adjustable-rate mortgage (option ARM). Under the optimal contract, the borrower is given discretion of how much to repay until his balance reaches a certain limit. The default rates and interest rate payment on the mortgage correlate positively with the market interest rate. Gains from using the optimal contract relative to simpler mortgages are the biggest for those who face more income variability, buy pricey houses given their income level or make little or no downpayment. Our model thus may help to explain a high concentration of option ARMs among riskier borrowers.

We identify and present original analyses of four methodological issues related to using Survey of Consumer Finances data sets and illustrate these issues with recent articles published in this journal. The issues are recognizing that the respondent is not necessarily the household head, reporting race and ethnicity in conformity with Survey of Consumer Finances and federal standards, using the repeated-imputation inference method to combine the five implicates in each survey year’s data set, and discussing the use of weighted or unweighted data in multivariate analysis. We found a considerable variation in how authors dealt with these issues, which could hinder replication or comparison of research results. Authors and reviewers should consider methodological issues related to the Survey of Consumer Finances more carefully.

Using the Survey of Consumer Finances: Some Methodological Considerations and Issues

In the 1990s and 2000s, inner city neighborhood redevelopment occurred throughout the United States as billions in public and private investments entered impoverished black communities. This revita...

Conceptualizing the New Urban Renewal: Comparing the Past to the Present

Previous academic studies viewed borrower rejection as a sign of market imperfections in the consumer credit markets, but this view was based upon the assumption that differences in the levels of borrower creditworthiness could not be accurately identified. Today, it is possible to differentiate between types of borrowers, and riskier borrowers can participate in credit markets if they are willing to pay relatively higher borrowing costs. Hence, a more critical issue concerning the performance of these markets should be whether loan prices correctly reflect the level of borrower credit risk. This paper reexamines consumer participation in credit markets looking specifically at issues related to the pricing of borrowers of different credit risk. ********** While an extensive academic literature examines the problem of limited household credit access, consumer credit use has increased significantly for almost two decades. During the late 1980s, researchers such as Luckett (1986) and Canner, Fergus, and Luckett (1988) were already discussing the various innovations in consumer credit markets that made it easier for consumers to finance their expenditures with credit. Automated credit scoring, the growth of asset securitization, and more flexible underwriting standards have encouraged greater competition among lenders to supply credit during the 1990s. Several years of robust economic growth have also stimulated the demand for all forms of credit. Although both supply and demand factors have led to rising mortgage, automobile, and revolving debts, substantially more research has been conducted on consumer credit constraints, while surprisingly very little attention has been given to the increase in credit access. This paper reexamines issues related to consumer credit market participation. Due to the lack of available repayment information, previous empirical studies could not distinguish between high- and low-risk borrowers and treated all rejected borrowers as "credit constrained." Moreover, the conventional wisdom view suggested that borrowers faced credit constraints because lenders did not have enough information to correctly assess credit risk. However, lenders do have information concerning borrower repayment history that can be used to price credit risk. The 1998 and 2001 Surveys of Consumer Finances (SCFs) also now include questions that can distinguish between differences in household credit quality.(1) Therefore, the first objective of this research is to investigate whether high-credit risk households do in fact account for most credit denials. If borrowers who traditionally would have been considered credit constrained are shown to lack creditworthiness based upon their observable loan repayment histories, then these rejections are not indicative of credit market inefficiencies. A second objective of this research is to gain more insight into the pricing patterns of loans in consumer credit markets. Rather than face rejection, high-risk households can participate in credit markets if they are willing to pay higher rates to compensate lenders for the additional risk. However, some borrowers having different levels of credit risk pay similar costs, and vice versa. If borrowers of high and low credit quality pay similar prices for credit or, conversely, borrowers with very similar credit quality characteristics obtain a wide range of credit prices and terms, then such findings may serve as better indicators of consumer credit market failures possibly arising from discrimination and/or predatory lending. For this reason, credit pricing is a more relevant issue today than credit rejection. LITERATURE REVIEW A large literature has tested for capital market imperfections by seeking evidence that households face liquidity or credit constraints. Research studies, such as Jappelli (1990), Canner, Gabriel, and Woolley (1991), Cox and Jappelli (1993), and Duca and Rosenthal (1993), have relied on questions from the 1983 SCF. …

Consumer Credit Risk and Pricing

What contributes most to borrower delinquency-"excessive" borrowing that results in greater financial stress or unforeseen negative income and wealth shocks? Using data from the 1998 Survey of Consumer Finances, this paper provides evidence that consumer delinquency problems are mainly the result of unexpected negative events that neither the lender nor the borrower could have anticipated at the time the credit request was evaluated. The size of the household payments burden has an insignificant effect on delinquency risk and very little effect on default risk. Finally, household financial assets that can be used as a buffer against negative shocks also serve as a very important predictor of delinquency risk. ********** Over the last two decades, households have been financing more of their expenditures using credit. Greater household debt use, larger amounts of credit borrowed, and broader distribution of consumer credit have generated concerns that households face greater financial stress. Household borrowing may be considered "excessive" since increasingly larger amounts of household income are being committed to payment obligations rather than saving. Given the fact that the U.S. personal savings rate has declined over the last decade, delinquency risk may be rising as households allow themselves to become "overextended," thereby jeopardizing their ability to meet all scheduled payment obligations. On the other hand, suppose rational households have accumulated some assets and expect future income streams to adequately cover their debt obligations. If rational lenders, who specialize in evaluating delinquency and default risk, adhere to optimal underwriting standards and validate borrower creditworthiness, then later delinquency problems should be unrelated to the simple fact that more household expenditures are being financed with credit. Subsequent repayment problems may result from unexpected declines in household wealth and future income that neither the household nor the lender could anticipate. For example, corporate mergers or bankruptcies often result in sudden job losses, a household consisting of two income earners may suddenly divorce, or various unanticipated changes in financial markets can erode the value of accumulated household assets. Hence, an alternative view would argue that unanticipated negative shocks to wealth and future income contribute more to rising borrower delinquency risk. This paper uses the 1998 Survey of Consumer Finances (SCF) to examine whether consumer delinquency risk is more likely to result from unanticipated economic shocks to household income and wealth or more likely to result from "excessive" household spending and mounting financial stress. Poor payment performance should be more likely to occur as a result of unanticipated random events and less likely to be related to the size of the household repayment burden if consumer credit markets are functioning properly. LITERATURE REVIEW While there is a large empirical literature on consumer liquidity and credit constraints, very little formal analysis pertaining to household indebtedness exists. Descriptive analyses by Kennickell, Starr-McCluer, and Sunden (1997) and Kennickell, Starr-McCluer, and Surette (2000) have documented trends in consumer indebtedness using the SCF. These studies report that the median level of household debt has continued to rise over the period from 1983 to 1998. (1) Yoo (1998) has also noted that more families are using credit cards and carrying higher balances over this period. In addition to greater use, Black and Morgan (1999) show that families with a wider range of economic characteristics are borrowing on credit cards. Rising household indebtedness is a concern if it eventually leads to a slowdown in economic activity. Economists such as Carroll and Dunn (1997) and Maki (2000) have explored the relationship between household debt growth and consumption, with Maki investigating specifically whether growth in consumer credit causes a reduction in future consumption. …

Contributing to the Delinquency of Borrowers

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Consumer Credit Risk and Pricing

Contributing to the Delinquency of Borrowers