Determinants of the closing probability of residential mortgage applications

Journal of Real Estate Research, The, 1997 by John P McMurray, Thomas A Thomson

Abstract. After allowing applicants to "lock" the interest rate, mortgage originators are concerned with protecting themselves from adverse outcomes due to interest-rate changes. One may expect applicants would strive to close applications when rates rose, while letting themselves fall out when rates decline. Our results show that applicant response to interestrate changes and volatility are modest. The most important predictor of closing probability is the length of the lock period, with shorter locks being more likely to close. Applications for single-family are more likely to close than are those for multiunit dwellings. Applications for owner-occupied properties are more likely to close than are those for investment properties. Applicant characteristics such as loan affordability, education and age have a small influence on closing rate. Gender has an effect for some loan programs, and marital status appears to be irrelevant. Discount points affect refinance mortgages more than purchase mortgages. Conventional applications are more likely to close than FHA and VA, and applications for refinance, in general, are less likely to close. Results are mixed for ARM and fifteen-year applications, as well as for whether it was the original application, or a relock.

Introduction

Upon application for a residential mortgage the potential borrower is typically offered the opportunity to lock in a current interest rate for the proposed loan. While this lock opportunity may be deferred, all applications must lock before closing as the paper work has to be prepared for a known loan contract. Loan lock periods vary, with forty-five and sixty days being the most common, though shorter locks may be used if the application process is nearly complete (i.e., the applicant allowed the interest rate to float during the application processing period). After locking, the application becomes part of the "mortgage pipeline". The mortgage originator then pursues a hedging strategy (which may be no hedging) to protect itself from the adverse effects of interest-rate changes between the date of the loan lock, and the date at which the closed loan will be sold into the secondary markets.

There are several reasons for a locked application to not close including: (i) the applicant may not qualify for the mortgage; (ii) the requisite underwriting package is not completed; (iii) defects in title or property; or (iv) interest rates decline and it is no longer in the applicants best interest to close. If the probability of a locked application becoming a closed one can be related to applicant characteristics, loan type and interest-rate movements, a mortgage originator can better manage the pipeline interest-rate risk it faces.

The importance of hedging the mortgage pipeline has been noted (McMurray, 1993; Scrowcroft, Davidson and Bhattacharya, 1988; Goodman and Jonson, 1987) but these studies do not attempt to measure the probability of a locked application closing. Rosenblatt and Vanderhoff (1992) pioneered closing probability research by directly assessing the probability of a locked application closing. A subset of their data is presented in a hazards context in Hakim, Rashidian and Rosenblatt (1995). This study extends the work of Rosenblatt and Vanderhoff (1992) by analyzing a more complete data set. The data set is more recent (1990-95 versus 1988-89), larger (about 55,000 locks versus 25,000), and it includes FHA and VA applications in addition to conventional applications. It contains information not present in Rosenblatt and Vanderhoff (1992) including interest-rate commitment on each application, measures of applicant characteristics, amortization period, reason for refinance (to tap equity or to capture a lower interest rate), and interest-rate volatility (an important options pricing variable). The data set is unique in that the information is recorded by the application lock being considered. McMurray (1994) notes that one must hedge applications by lock, not by whether the applicant ultimately closes a loan, indicating the need for a study based on application locks. The purpose of this study is to empirically analyze determinants of mortgage closing probability, which is an important first step in determining how best to hedge the mortgage pipeline. We present an overview of the data, details about the empirical model variables, an econometric analysis, and summary of our findings.

The Data

Our data is for applications made to a nationally oriented mortgage originator during the January 1990 to January 1995 period, which includes periods of both rising and falling interest rates. The data set includes FHA, VA and conventional applications for fixedand variable-rate mortgages with fifteen- and thirty-year amortization periods. From about 44,000 loan applications, there are in excess of 55,000 interest-rate locks.

Most applications locked once, but about 9,000 experienced multiple locks. The original number of lock days varied from 1-600 days, with an average of 46 days. About 43% of the locks were for 45 days, and 38% for 60 days. Less than 0.2% are for locks greater than 90 days. For applications that experienced one relock, the average relock period was 20.4 days. For those that relocked a second, third, fourth, or fifth time, the average lock period was for 23, 25, 43, and 48 days, respectively.