Some of the most difficult risks to quantify in the mortgage market involve the ups and downs of human life. Lost or new jobs, changes to borrowing habits, a child in college, births, deaths, and, of course, health.
The risk of a major illness isn’t just a matter of personal circumstances. In addition to undergoing treatment, patients might have to shoulder high out-of-pocket medical costs, lost income, and even the possibility of a lifetime on medication.
Unfortunately, those burdens can also undermine the ability to pay for one’s home.
A recent Columbia University working paper found that cancer diagnoses have a major impact on foreclosure rates. The worst part is that even health insurance coverage doesn’t help much. Insured or not, borrowers with low levels of equity in their homes are the most at risk for financial trouble, a finding that is of significant importance to the non-Qualified Mortgage (non-QM) market.
With 40 percent of Americans facing a cancer diagnosis in their lifetimes, non-QM lenders absolutely have to understand the risks and help both their customers and themselves to plan ahead.
Cancer: Undermining health and wealth
While cancers obviously vary in malignancy and treatment, diagnosis generally brings a raft of new expenditures: a 2011 survey found that 13 percent of patients spent over 20 percent of their incomes on out-of-pocket expenses related to treatment. A Duke University study of cancer patients seeking help with medication costs found that their out-of-pocket expenses averaged $712 per month — and notably, all but one of the 216 participants had health insurance. Other studies have discovered alarming rates of dose-skipping or medication-halting among cancer patients attempting to mitigate costs.
These financial burdens filter through to mortgage payments.
The Columbia study found that in the five years following diagnosis, foreclosure rates among cancer patients rose by 65 percent. For borrowers with health insurance, the foreclosure rate rose over 50 percent. While the results are still preliminary, they offer a sobering insight: health insurance helps, but doesn’t eliminate, the financial instability that cancer can bring.
The paper underscores and supports the large body of research investigating health insurance and another measure of financial distress — personal bankruptcy. One prominent study, co-authored by Senator Elizabeth Warren while she was a Harvard professor, determined that medical expenses were behind 62 percent of bankruptcies. While the percentage impact varies from one study to another, the general consensus is that medical debts are a leading factor (if not the leading factor) contributing to personal bankruptcy.
But it’s not just the cost of medicine
While greater levels of insurance coverage do, at least, reduce medically-driven bankruptcies — a study in Massachusetts, which mandated coverage in 2005, found that medical costs drove a fraction of bankruptcies in the state in comparison with the rest of the nation — the risk that arises from cancer and other health crises isn’t just a function of medical costs.
Just like companies, families and individuals have capital structures, and the more levered they are, the less resilient they’ll be.
Indeed, the foreclosure rates found in the Columbia sample were completely driven by the borrower’s level of home equity.
For a subsample of 10,000 borrowers for whom data was available, the researchers found that homeowners who had a loan-to-value ratio of less than 100 at origination enjoyed a decline in foreclosure rates. These borrowers were able to access their equity to make up for the cost of cancer — and they often did so, increasing leverage in the five years following diagnosis.
On the other hand, for borrowers who borrowed more than the value of their home, foreclosure probability increased by 90 percent. Looking at current loan-to-value at the time of diagnosis, the researchers found that patients with a ratio of over 80 missed an average of six payments in the five years that followed.
Higher leverage simply begets higher risk and less ability to cushion financial shocks.
The findings illustrate the perhaps obvious but significant limitations that low home equity places on borrowers. For patients who don’t have the option to use home equity to smooth income and expenses, cancer can be financially disastrous.
So what’s a lender to do?
Mortgage lenders can’t control their borrowers’ health, nor can they resolve the complications and costs of medicine. Thus, mitigating these risks comes down to preparing for them internally and helping borrowers to understand their individual capital structures.
Health risk is a factor that simply has to be part any lending model. While a single borrower’s health prospects are unknown, a global understanding of the probability and cost of health shocks on a group of borrowers is an important part of the analytical process. Again, with 40 percent of Americans expected to face cancer at some point in their lifetimes, it’s also a necessary one.
There is also the matter of leverage. Non-QM lenders need to be sure that their customers understand the risks that come with high loan-to-value ratios, and that borrowers have the ability to make up for shortfalls in income through other means. Credit, as the old saying goes, is easiest to get when you don’t need it, so clients need to understand that preparing for emergencies through savings or other financial routes has to be an ex ante concern.
An extra service, perhaps, but one that can help both borrowers and their banks. The fact is that we all face the possibility of a health crisis — the only thing we can do is to prepare.
This article was written exclusively for GoRion.