Bankruptcy Exemptions, Credit History, and the Mortgage Market

We develop and test a model of mortgage underwriting, with particular reference to the role of credit bureau scores. In our model scores are used in a standardized fashion, which reflects the prevalence of automated underwriting in industry practice. We show that our model has implications for the debate on the effect of personal bankruptcy exemptions on secured lending. Recent literature (Berkowitz and Hynes (1999), Lin and White (2001)) has developed conflicting theories - and found conflicting results - seeking to explain how exemptions affect the mortgage market. By contrast, our model implies that when lenders use credit scores in a standardized manner, exemptions should be irrelevant to the mortgage underwriting decision. Merging data from a major credit bureau with the Home Mortgage Disclosure Act (HMDA) dataset, we confirm this prediction of our model. We also show that while ignoring borrower credit quality may make exemptions appear to be significant, once one controls for credit scores then exemptions have no effect on the likelihood that a mortgage application is approved. We confirm this empirically and argue that this may help explain some of the results of the previous literature