The Role of Soft Information in a Dynamic Contract Setting: Evidence from the Home Equity Credit Market

Abstract

Credit underwriting is a dynamic process involving multiple interactions between borrower and lender. During this process, lenders have the opportunity to obtain hard and soft information from the borrower. We analyze more than 108,000 home equity loans and lines-of-credit applications to study the role of soft and hard information during underwriting. Our dataset allows us to distinguish lender actions that are based strictly on hard information from decisions that involve the collection of soft information. Our analysis confirms the importance of soft information and suggests that its use can be effective in reducing overall portfolio credit losses ex post.

Keywords: Information, Contract Frictions, Screening, Banking, Home Equity Lending

JEL Classification: D1, D8, G21