The Role of Insurance in Debt Renegotiation: Evidence from Mortgage Market

Posted: 3 Jun 2014 Last revised: 8 Jan 2017

See all articles by Sumit Agarwal

Sumit Agarwal

National University of Singapore

Yunqi Zhang

School of Finance, Nankai University; National University of Singapore

Date Written: May 1, 2014

Abstract

This paper studies the effects of debt insurance on the likelihood of debt renegotiation with the setting of mortgages. Mortgage insurance enables mortgage holders to potentially get compensation for the loss in mortgage investment resulting from borrower’s default and subsequent liquidation. If a mortgage loan becomes delinquent, the borrower may apply for mortgage modification. According to moral hazard theory, mortgage holders are less likely to accept mortgage modification if mortgages are guaranteed by mortgage insurance, because their loss can be paid by the insurance company. We empirically test this effect using datasets including detailed information of mortgage origination and performance. We find that higher insurance coverage leads to lower likelihood of modification and the magnitude of this moral hazard effect is significant. This paper helps us better understand mortgage holders’ reluctance to modify mortgage loans, an important factor of the higher liquidation rate in the financial crisis.

Keywords: debt renegotiation, financial crisis, loan modification, mortgage, insurance, foreclosure, loss mitigation

JEL Classification: D1, D8, G1, G2

Suggested Citation

Agarwal, Sumit and Zhang, Yunqi, The Role of Insurance in Debt Renegotiation: Evidence from Mortgage Market (May 1, 2014). Available at SSRN: https://ssrn.com/abstract=2444176 or http://dx.doi.org/10.2139/ssrn.2444176

Sumit Agarwal

National University of Singapore ( email )

15 Kent Ridge Drive
Singapore, 117592
Singapore
8118 9025 (Phone)

HOME PAGE: http://www.ushakrisna.com

Yunqi Zhang (Contact Author)

School of Finance, Nankai University ( email )

38 Tongyan Road, Jinnan District
Tianjin, Tianjin 300350
China

National University of Singapore ( email )

4 Architecture Drive
Singapore, 117566
Singapore

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