Mortgage underwriting has a blind spot: The homeowner’s largest risk

Mortgage finance is exceptionally sophisticated at measuring the risk that a homeowner poses to a lender. It measures credit score, debt-to-income ratio, loan-to-value, income stability, reserves and property valuation. Yet there is a striking omission in the architecture of American housing finance: We do very little about the enormous concentration risk that the home itself creates for the homeowner. For most households, buying a home means making a highly leveraged investment in one specific asset. No investment adviser would recommend placing most of a household’s net worth into a single stock. Yet housing finance routinely facilitates something economically similar: A household places a substantial portion of its wealth into one individual property and then borrows heavily against it. The mortgage industry has largely treated that concentration as unavoidable, but it may not be. Mortgage credit risk and homeowner risk are connected We traditionally think of mortgage risk from the lender’s perspective. But a homeowner whose individual property falls substantially in value becomes a riskier borrower. The homeowner’s equity disappears, mobility declines and refinancing becomes mo...