Financial Literacy, Broker-Borrower Interaction, and Mortgage Default

Abstract

This paper examines the relationship between broker-borrower interaction in the origination process and subsequent mortgage performance. I show that face-to-face interaction between a mortgage broker and borrower before the loan funds is associated with lower levels of ex post default. The relation between face-to-face broker-borrower interaction and mortgage performance holds only for borrowers that have characteristics associated with low levels of financial literacy. Specifically, face-to-face interaction is negatively related to default for minorities, borrowers located in areas with low levels of education, low-income borrowers, and borrowers with low FICO scores. Moreover, the relation between default and broker-borrower interaction is significant only for certain loan products (adjustable rate mortgages, low income documentation loans, cash-out refinances) that have been linked to low levels of financial literacy. My analysis also indicates that broker screening, lender underwriting, and unobservable characteristics of the borrower or broker are unlikely explanations for the relationship between broker-borrower interaction and default. Taken together, my results suggest that face-to-face interaction between the mortgage broker and borrower may reduce problems associated with financial illiteracy.