Seller Contributions and Mortgage Performance: Settling a Controversy

In recent years, the mortgage industry has witnessed an increasing trend of financial assistance from sellers, commonly known as seller contributions. While seemingly beneficial for homebuyers, this practice has significant implications for mortgage performance and property valuation. Our latest study delves into the effects of seller contributions on mortgage delinquency rates, uncovering critical insights that underscore why this issue matters to lenders, borrowers, and policymakers alike.

Understanding Seller Contributions and Their Impact

Seller contributions occur when the seller of a property offers financial assistance to the buyer, often to cover closing costs. This assistance can inflate the transaction price, thereby distorting the loan-to-value (LTV) ratio, a critical metric used in mortgage underwriting. Our research reveals that mortgages with seller contributions display sharply increased rates of delinquency, even after adjusting for the inflated LTV ratio. This finding is particularly concerning because it indicates that the issue extends beyond simple valuation inaccuracies.

Key Findings of the Study

1. Increased Delinquency Rates

Loans with seller contributions have delinquency rates 1.4 to 1.7 times higher than those without such contributions. This elevated risk persists even after accounting for the LTV distortion caused by the inflated transaction price.

2. Liquidity Constraints

The relationship between seller contributions and mortgage delinquency is particularly significant when the contributions are likely requested by buyers rather than offered by sellers. This pattern indicates that buyers requesting such contributions may be experiencing liquidity constraints, making them more vulnerable to financial shocks and, consequently, more likely to fall behind on mortgage payments. If a buyer needs help making his down payment he is more likely to have problems making his monthly payments as well. 

Historically, appraisers have believed that seller contributions were not detrimental if they were “typical of the market.” However, this notion is inaccurate. What appraisers observed, albeit indirectly, is that concessions are less damaging when the seller offers them. Sellers tend to offer concessions in a declining real estate market, often referred to as a “buyer’s market.” The misconception lies in the belief that the commonality of the practice makes it acceptable. What truly matters is who initiates the contribution, and it just so happens that when the seller is in a bad position, other sellers tend to be in a bad position while a buyer having problems will generally be alone. They noticed a real correlation, but they got the causes wrong.  

3. Historical and Current Trends

Seller contributions have become more prevalent since 2009, with over half of all purchase mortgages acquired by Fannie Mae since 2016 including some form of seller assistance. The impact on delinquency was particularly strong during the housing market downturn of 2006-2009, moderating somewhat in the following years but picking up again in 2018. 

Why These Findings Matter

The findings from this study highlight several important implications for the mortgage industry and housing market:

Risk Management

Lenders need to be aware of the added risk posed by seller contributions. This awareness is crucial for accurate risk assessment and for developing strategies to mitigate potential losses. The study suggests that traditional LTV measurements may not fully capture the risk associated with these loans.

Policy Implications

Policymakers should consider regulations that address the implications of seller contributions. Current policies that limit seller contributions based on LTV thresholds may need to be revisited to ensure they adequately mitigate the associated risks.

Buyer Awareness

Prospective homebuyers should understand the potential long-term risks of relying on seller contributions. While these contributions can make home purchases more affordable upfront, they may signal financial instability that could lead to difficulties in maintaining mortgage payments.

Conclusion

Seller contributions, while helpful for facilitating home purchases, pose significant risks to mortgage performance. Our study underscores the importance of accurately assessing these risks and highlights the need for both lenders and policymakers to consider these factors in their decision-making processes. By understanding the nuanced impacts of seller contributions, the industry can better navigate the complexities of mortgage underwriting and maintain a more stable housing market.

References

1. Hayunga, D.K. (2018). Sales Concessions in the US Housing Market.
2. Johnson, K., Anderson, R., & Webb, J. (2000). The capitalization of seller-paid concessions.
3. Cotterman, R.F. (1992). Final Report: Seller Financing of Temporary Buydowns.
4. Woodward, S.E. (2008). A study of closing costs for FHA mortgages.
5. McFarlane, A. (2012). The Impact of Limiting Sellers’ Concessions to Closing Costs.

By addressing these insights, the mortgage industry can work towards reducing delinquency rates and ensuring more accurate property valuations, ultimately fostering a healthier and more resilient housing market. For more detail on this topic, I would be happy to send you a copy of the paper. Please reach out to me at franklin.carroll@mykukun.com; the above article is based on a paper I wrote with Nuno Mota, Weifeng Wu, and Eric Rosenblatt. If you prefer to avoid uncomfortable human interaction, you can purchase the full paper here from the publisher: Seller Contributions and Mortgage Performance | The Journal of Real Estate Finance and Economics (springer.com)

Franklin Carroll

Franklin Carroll is Kukun's VP of Modelling and Analytics; After finishing his studies at the University of Chicago, he worked at Fannie Mae where he helped build Collateral Underwriter, roll out the Value Verify initiative, and specialized in collateral related and credit related policy.

Published July 1, 2024