Conventional mortgage underwriting evaluates borrowers andloan characteristics but gives comparatively..

Beyond the Borrower: How Place Exposes the Blind Spot inMortgage Risk

Abstract

Conventional mortgage underwriting evaluates borrowers andloan characteristics but gives comparatively little attention to the localenvironments in which mortgages perform. This article argues that place—theevolving economic, demographic, housing, neighborhood, social, and healthcharacteristics of a community—is an independent dimension of mortgage risk.Drawing on three decades of research in urban economics and mortgage finance,it shows how place influences collateral values, borrower behavior, default,and loss severity. Empirical evidence demonstrates that measures of placeprovide substantial predictive information beyond traditional credit scores.The article describes how these insights led to the development of ForeScore™,a framework for characterizing place and incorporating local conditions intomortgage risk assessment. It concludes that the future of mortgage riskmanagement lies in integrating borrower information with dynamic measures ofplace and using scenario-based forecasting to evaluate uncertainty.

Introduction

Most discussions of mortgage risk begin with the borrower.

Mine began with a housing market.

In 1979 my family and I moved to Vancouver and bought ourdream home. It seemed like an ordinary decision. Instead, it became anunexpected lesson in how quickly the economics of homeownership can change inan uncertain world.

Over the next one and a half years, local house pricesdoubled in real terms.  At the same time,the one-year mortgage we had taken out at 12 percent came due for renewal justas Canadian mortgage rates rose toward 22 percent.  Suddenly the economics of homeownershiplooked very different. For anyone buying a home, the monthly cost of owning hadnearly quadrupled.

Figure 1: The Vancouver House Price Eruption

I worked for the same employer, earned the same salary, andlived in the same house. The mortgage contract itself had not changed a singlesyllable.

The explanation lay somewhereelse.

Only much later did I realizewhat had happened. Iwasn't simply living in Vancouver--I was living in a housing market, andthat housing market had changed dramatically.  

Vancouver was still the same beautiful city. Buteconomically it had become a very different place.

The streets, neighborhoods andhouses looked much the same, but the economic reality of living there hadchanged profoundly. Homeownership that seemed attainable only months earlierwas suddenly out of reach for thousands

Figure 2: The Volcker InterestRate Spike

As the head of a household, I had to worry about making themortgage payment. As a researcher, I became fascinated by a different question.

How could exactly the samemortgage represent such different risks only eighteen months later without theborrower, the mortgage contract, or the house changing?

That question would anchor my research for the next threedecades.

The First Question

The first question wasdeceptively simple.

Was Vancouver unusual, or didother housing markets behave the same way?

As I began looking beyondVancouver, I discovered something surprising. Cities exposed to the samenational economy often behaved very differently. Some experienced dramaticbooms and busts while others remained remarkably stable. Interest rates,inflation, and national economic conditions affected everyone, yet theireffects varied enormously from one metropolitan area to another.

The common national environmentcould not explain those differences.

Something local was at work.

Every metropolitan area seemed tohave its own economic personality, shaped by local industries, migration, landavailability, demographics, and countless other influences. National conditionsmattered, but they were filtered through local economic conditions. Similarcities often followed very different paths because their local economiesresponded differently to the same external forces.

Instead of asking why thenational housing market behaved the way it did, I began asking why individualhousing markets behaved so differently from one another. The distinction mayseem subtle, but it proved to be fundamental.

Figure 3: Diverse Reactions tothe Same National Economic Environment

This figure illustrates thediversity of reactions of local house prices to common national economicconditions. Some areas experienced the “bubble” preceding the financial crisis,others did not. Notice the extreme volatility of the Miami metro versus thelimited movement in Detroit.

Understanding those differencesrequired looking beyond house prices alone. Prices reveal where a market hasbeen, but they do not explain why it arrived there. To understand local marketdynamics, I began examining rents, affordability, employment, populationgrowth, construction activity, and the balance between housing supply anddemand. Each variable provided another clue, but no single measure captured thefull picture.

Gradually, a broader frameworkbegan to emerge. Housing markets are complex adaptive systems in which economicforces, household behavior, financing conditions, and local institutionsinteract continuously. Small differences in local conditions can producesurprisingly different outcomes over time.

That insight explained far morethan Vancouver.

It suggested that what I hadexperienced was not an anomaly. It was the consequence of living in aparticular housing market with its own unique economic characteristics.

At the time, I thought I wasstudying housing markets.

I didn't yet realize that I was beginning to study what Iwould eventually come to think of as place.

The Fundamentals of Place

If every housing market had its own economic personality, theobvious question was why.

At first glance, house prices seem to provide the answer.Markets with strong demand experience rising prices; weaker markets do not. Butprices are only the visible outcome of much deeper economic forces.Understanding those forces required looking beyond the housing market itself.

Cities are not static. They evolve over decades throughcountless decisions made by households, businesses, developers, and localgovernments. Where people choose to live, where firms choose to invest, whenfarmland is converted to urban uses, how transportation networks develop, andhow neighborhoods change over time all influence the long-run value of urbanland.

Every one of those decisions is made under uncertainty.  

A developer deciding whether to convert agricultural land toresidential use cannot know with certainty how rapidly the city will grow,where future employment will concentrate, or whether today's demand willpersist. Waiting preserves the option to develop later, when more informationis available, but it also risks missing a period of strong demand and risingland values. Developing too soon, on the other hand, commits capital that mayearn disappointing returns if growth slows or shifts elsewhere. The decision isvaluable precisely because waiting has value. As new information arrives,today's best decision may no longer be tomorrow's best decision.

This realization became the focus of much of my research.Rather than treating land values as simply the outcome of supply and demand, Ibecame interested in the economic process through which cities evolve. Growth,expectations, and uncertainty interact to shape urban structure, and thatevolving urban structure determines the long-run value of land and thecollateral built upon it.

The work eventually led to a series of papers examining thefundamentals of urban land prices and the role of uncertainty in the evolutionof cities. The central idea was straightforward but far-reaching: land valuesare not determined solely by current economic conditions. They also reflectexpectations about the future and the value of preserving flexibility when thatfuture is uncertain.

That insight changed the way I thought about housing markets.House prices were no longer simply observations to be explained. They weresignals of deeper economic processes operating within local economies.

At the time, I thought I was answering a question aboutcities.

Only later did I realize I was answering the question thathad begun in Vancouver.

Understanding how places evolve proved to be the first steptoward understanding mortgage risk.

An Unexpected Connection

For many years, I thought my urban research had little to dowith mortgages.

My work focused on understanding how local economies shapethe long-run value of urban land. I was interested in growth, uncertainty, andthe economic forces that determine why seemingly similar cities evolve sodifferently over time. Mortgage finance was not the objective.

Then I realized that I had been looking at one side of a muchlarger problem.

Every mortgage has two essential components. The first is theborrower's promise to repay. The second is the collateral that secures thatpromise. Although these two components are inseparable in practice, they hadlargely been studied in different disciplines. Credit analysts focused onborrowers. Urban economists focused on housing markets.

The collateral connected them.

Collateral is where place becomes finance.

The value of a house is not determined solely by its physicalcharacteristics. It depends on the economic vitality of the local market inwhich it exists. Employment opportunities, population growth, housing supply,neighborhood characteristics, demographic change, and other local forcesdetermine not only what a property is worth today, but how that value is likelyto evolve over time.

That realization changed the questions I was asking.

If local economic conditions shape collateral values,shouldn't they also influence mortgage risk? If two borrowers have identicalcredit profiles but own homes in markets with very different economicprospects, are the risks really the same? And if uncertainty influences theevolution of cities, doesn't it also influence the security on which everymortgage ultimately depends?

These questions suggested that housing economics and mortgagefinance were not separate fields after all. They were different perspectives onthe same underlying problem.

I had spent years studying the economic processes that createcollateral value.

Only later did I realize that collateral is where urbaneconomics and mortgage finance intersect.

Understanding how places create and sustain collateral valuewas also the first step toward understanding mortgage risk.

Collateral Is Not Static

The more I thought about mortgages, the more I realized thatcollateral is often treated as if it were a fixed quantity.

A lender orders an appraisal, determines the current marketvalue of the property, and establishes a loan amount based on that estimate.Once the loan is made, the collateral largely disappears from the analysisuntil the loan is refinanced or a borrower defaults.

That approach is understandable, but it overlooks somethingfundamental.

Collateral is not static.

The value of a house is not determined once and preserved forthe life of the mortgage. It changes continuously as the local economy evolves.Employment expands or contracts. New businesses open while others close.Population grows or declines. Transportation improvements alter accessibility.New construction changes the balance between supply and demand. Neighborhoodsimprove, stagnate, or deteriorate.

Each of these changes affects the economic environment inwhich the property exists.

The house itself may be little different from the day themortgage was originated. The structure ages gradually, perhaps with modestimprovements or deferred maintenance. What changes far more dramatically is thevalue of the land beneath it, reflecting changing expectations about the futureof the surrounding community.

This realization was a direct extension of my earlier work inurban economics. If land values are shaped by growth, expectations, anduncertainty, then the collateral supporting a mortgage must also evolve asthose forces change.

The implication was straightforward but important.

Mortgage risk cannot be understood solely from informationavailable at origination. Borrower characteristics may remain unchanged, yetthe quality of the collateral can improve or deteriorate as local economicconditions change. Conversely, strong collateral can offset some forms ofborrower risk, while weakening collateral can magnify it.

The mortgage itself does not change.

The borrower may not change.

The local economy does.

And because the local economy changes, the nature of thecollateral changes with it.

This shifted my perspective on mortgage lending. An appraisalprovides an estimate of value at a single point in time. Mortgage risk,however, unfolds over years. Understanding that risk requires understanding howthe economic environment supporting the collateral is likely to evolve,especially during periods of uncertainty.

Collateral, I came to realize, is not simply an assetsecuring a loan.

It is a living expression of the local economy.

Mortgages don't perform in a vacuum

Thinking of collateral as a dynamic asset changed the way Ithought about mortgage performance.

For decades, mortgage underwriting has focused primarily onthe borrower. The emphasis is understandable. Borrowers make the payments.Their income, credit history, debt obligations, and financial reserves providethe first line of defense against default.

Those factors remain essential.

But they are not the whole story.

Borrowers experience financial difficulties within thecontext of the places in which they live. Housing markets are one part of thatenvironment, but so are local employment opportunities, demographics,neighborhood conditions, and the broader economic forces that shape householdresilience.

Consider two homeowners with similar mortgages, comparablecredit histories, and identical incomes. Suppose both unexpectedly lose theirjobs. On paper, their financial situations appear identical. In reality, theymay face very different futures.

If one homeowner lives in a market with rising propertyvalues and active demand, selling the house may be a realistic option.Refinancing may also be possible if equity has increased. Financial hardship isstill painful, but the local market provides alternatives that may allow theborrower to avoid default.

The second homeowner may have none of those options. If localproperty values have declined, marketing times have lengthened, and demand hasweakened, selling the property may not generate enough to repay the mortgage.Refinancing may be impossible. The same financial shock now has very differentconsequences. The borrower did not change. The environment did.

The difference is not simply the borrower.

It is the interaction between the borrower and place. Placeencompasses the local economic, housing, demographic, and neighborhoodconditions that shape both collateral and borrower behavior over time.

This realization led me to a different way of thinking aboutmortgage risk. Mortgage performance reflects two independent sources ofuncertainty. One arises from the borrower. The other arises from place. Theborrower's circumstances determine the ability to pay. Place determines theenvironment in which that ability is tested. Neither dimension can fullyexplain mortgage performance without the other.

This perspective did not diminish the importance ofunderwriting. It expanded it. Evaluating a mortgage required understanding notonly the borrower but also the local economy supporting the collateral.

That insight also changed the way I thought about defaultitself.

Default is often described as a borrower decision. Inpractice, it is frequently the outcome of a changing relationship between theborrower's financial condition and the evolving value of the collateral. Thelocal housing market influences that relationship every day the mortgageremains outstanding.

Years later I would discover that borrowers with nearlyidentical credit scores experienced dramatically different default ratesdepending on the places in which they lived.

Once viewed in this way, another question naturally emerged.

If local market conditions influence whether borrowersdefault, shouldn't they also influence the losses lenders experience whendefaults occur?

When Default Is Only the Beginning

Understanding why borrowers default answered only part of theproblem.

For lenders and investors, default is not the final outcome.It is the beginning of a new and often uncertain process. The ultimate questionis not simply whether a borrower stops making payments, but how much of theoutstanding loan balance can ultimately be recovered.

That question shifts attention from the borrower to thecollateral.

Once a loan enters foreclosure, the lender inherits all ofthe uncertainty embedded in the place where that collateral exists. Theproperty must be marketed, sold, and converted back into cash. The outcomedepends on much more than the physical characteristics of the house. It dependson the condition of the market into which it is being sold.

In a healthy market, buyers are active, marketing times arerelatively short, and transactions provide reliable evidence of value. Evenafter accounting for foreclosure costs, losses may be modest.

Under stressed market conditions, the situation can be verydifferent. Buyers become scarce, marketing times lengthen, comparable salesbecome more difficult to interpret, and prices often decline as uncertaintyincreases.

The lender is no longer simply selling a house. It isattempting to liquidate collateral in a market that is itself under stress.

The distinction proved to be important.

Two mortgages with identical loan balances and similarborrowers can produce very different losses if they are located in differenthousing markets. The difference is not explained solely by the propertiesthemselves. It reflects the economic environment in which those properties aresold.

This realization reinforced an idea that had been developingthroughout my research.

Collateral is more than security for a loan. It is a claim onthe future economic value of a place. When that economy is healthy, collateralperforms its intended function. When the local economy weakens, the value ofthat security becomes more uncertain precisely when lenders depend on it most.

The more I studied mortgage losses, the more I came toappreciate that place influences every stage of the lending process. It shapescollateral values before a loan is made. It influences the options available toborrowers when financial difficulties arise. And it largely determines howlenders recover value when defaults occur.

The implications extended far beyond individual mortgages.They affected the behavior of entire portfolios.

If local market conditions influence both borrower outcomesand collateral performance, then they also influence the risk of entiremortgage portfolios.

That realization raised yet another question.

If location plays such an important role in mortgageperformance, why wasn't it being measured more systematically?

Once I understood that lenders ultimately own the risk ofplace, measuring place no longer seemed optional. It became essential.

The Financial Crisis: When Theory Met Reality

For many years, my research had been driven by curiosityrather than urgency.

I wanted to understand why places evolve differently, howuncertainty shapes urban land values, why collateral changes over time, and howthose changes influence mortgage performance.

Then came the financial crisis.

Almost overnight, questions that had occupied a relativelysmall community of housing economists became central to the global financialsystem. Markets that had appeared stable for years began to unravel. Homeprices fell sharply in many metropolitan areas, mortgage defaults increased,and losses spread rapidly through financial institutions around the world.

What struck me most was not simply the scale of the crisis.

It was how differently local housing markets responded.

Some metropolitan areas experienced severe and prolongeddeclines. Others proved remarkably resilient. Similar mortgage portfoliosperformed very differently depending on where the underlying properties werelocated. The patterns I had been studying for years became impossible toignore.

The crisis reinforced a lesson that had been emergingthroughout my research.

Mortgage risk is not determined solely by borrowers or loanterms. It is also shaped by place—the evolving economic environment in whichborrowers live and collateral exists. When that environment deteriorates,declining property values, weakening demand, and longer marketing times combineto increase uncertainty at exactly the moment lenders are most dependent on thevalue of the collateral.

In retrospect, this should not have been surprising.

If local economic conditions influence land values, ifchanging land values influence collateral, and if collateral determinesrecovery following default, then widespread changes in local housing marketswere bound to have profound consequences for mortgage portfolios.

The crisis did not create these relationships.

It revealed them.

It also exposed an important weakness in the industry'sapproach to mortgage risk. Borrower information was measured in extraordinarydetail. Loan characteristics were carefully documented. Yet the characteristicsof place—the environment in which borrowers and collateral interact—were oftenrepresented by only a handful of broad indicators, or ignored altogether.

That realization transformed the next question. The challengewas no longer simply to understand place. The challenge was to measure it. Onlythen could it become part of everyday mortgage decisions.

It was to find a practical way to measure those influencesbefore the next crisis arrived.

From Theory to Practice

The financial crisis demonstrated that place plays a centralrole in mortgage risk. It also exposed a practical problem.

Knowing that place matters is not the same as being able tomeasure it consistently.

Lenders, investors, and rating agencies make decisions everyyear about millions of mortgages. Those decisions cannot rely on broadobservations about housing markets or on detailed academic models that requiremonths of analysis. They require measures that are objective, consistent,transparent, and available at the time decisions are made.

The challenge was no longer purely academic.

How could decades of research on housing markets betranslated into tools that practitioners could actually use?

That question led me into a different environment.

Working with mortgage investors and rating agencies,especially Fitch, I found that the questions practitioners asked wereremarkably similar to the ones that had motivated my research for years. Theywanted to understand why mortgages with similar borrower characteristics oftenperformed differently. They wanted to know why losses varied so dramaticallyacross metropolitan areas. Most importantly, they wanted to distinguish betweentemporary market fluctuations and fundamental differences in the environmentsin which mortgages perform.

One question emerged repeatedly.

Does place matter as much as the borrower?

Throughout this research, I use the word place deliberately.Place is more than a geographic location. It is the economic, demographic,housing, neighborhood, social, and health environment in which borrowers liveand collateral performs. These characteristics are shared by everyone in acommunity, yet they vary dramatically from one community to another.

If place truly influences mortgage performance, then itshould provide information that traditional borrower measures do not.

To test that idea, I compared future mortgage performanceusing two independent dimensions of risk: traditional borrower credit scoresand ForeScore's measure of place.

Table 1: Borrower Credit and Place Are Independent Dimensionsof Mortgage Risk

Future mortgage default rates cross-classified by traditionalcredit score and ForeScore™ demonstrate that place provides substantialinformation about future mortgage performance beyond borrower creditcharacteristics alone.

This table illustrates how credit scores and ForeScore™jointly separate mortgage loans into well-defined risk categories. Rows compareborrowers with similar ForeScores across different credit scores. Columnscompare borrowers with similar credit scores across different ForeScores. Thedata are based on a random sample of 47,000 mortgage originations with realizeddefaults observed over the subsequent seven years.

The results were striking. Within every credit-scorecategory, future mortgage performance varied systematically across ForeScore™categories. Likewise, within every ForeScore™ category, borrower creditcontinued to distinguish risk. Neither measure replaced the other. Togetherthey revealed dimensions of mortgage performance that neither could explainalone.

The table illustrates a simple but powerful idea: mortgagerisk has two independent dimensions. One reflects the borrower's financialhistory. The other reflects the resilience of the place in which that borrowerlives. Ignoring either leaves important information unexplained.

These results reinforced the conclusion that had emergedgradually over three decades of research. Mortgage performance reflects bothborrower characteristics and place. ForeScore™ was developed to operationalizethat second dimension.

The column for borrowers with an average credit score of 631provides a clear illustration. Traditional valuation treats these borrowers asbroadly comparable. Yet their realized default rates range from only 4 percentin the strongest ForeScore™ locations to 19 percent in the weakest—a nearlyfive-fold difference.

Their credit histories were essentially the same.

Their places were not.

That result confirmed what the earlier research had beensuggesting for years.

Mortgage performance depends on both the borrower and theenvironment in which the borrower and the collateral exist.

Academic research seeks to improve understanding. Practicalrisk management requires consistent measurement. Bridging those two worldsproved to be both challenging and rewarding.

The objective was never to replace traditional underwriting.Borrower characteristics remain fundamental to mortgage lending. The objectivewas to complement borrower information with an equally systematic understandingof place, providing lenders and investors with a more complete picture offuture mortgage risk.

That realization became the foundation on which ForeScore™was built.

ForeScore: Operationalizing Place

The cross-tab demonstrated that place contains informationabout future mortgage performance that traditional borrower measures do not.

The next challenge was practical.

How do you characterize place consistently across thousandsof communities, and how do you update that characterization as thosecommunities evolve?

That question became the foundation for ForeScore.

Place cannot be represented by a single statistic. It is theproduct of many interacting forces: economic conditions, housing markets,demographic trends, neighborhood characteristics, public health, and otherlocal influences that shape both borrower resilience and collateralperformance. No single measure captures that complexity. The challenge is tointegrate those diverse signals into a consistent description of theenvironment in which mortgages exist.

ForeScore™ was designed to meet that challenge.

Unlike a credit score, ForeScore™ does not evaluate anindividual borrower. Unlike an appraisal, it does not estimate the value of anindividual property. Instead, it characterizes the place in which borrowerslive and collateral performs.

That distinction is fundamental.

Traditional underwriting measures the borrower.

Appraisals measure the property.

ForeScore™ characterizes the place in which they interact.

Because places evolve continuously, their risks evolve aswell. Economic conditions change. Housing markets strengthen or weaken.Demographic patterns shift. Neighborhoods improve or decline. The environmentsurrounding a mortgage is never static, and understanding that changingenvironment is essential to understanding long-term mortgage performance.

In many ways, ForeScore™ represents the convergence ofseveral decades of research. The work on urban land values explained how citiescreate value. Research on local housing markets demonstrated why metropolitanareas respond differently to economic shocks. Studies of collateral andmortgage performance showed how those differences influence default and loss.The financial crisis underscored the consequences of overlooking thoserelationships.

Each stage of the research answered one question whilerevealing another.

ForeScore™ was not conceived as a new theory of mortgagerisk. It was conceived as a practical way of operationalizing place—a frameworkthat translates decades of research into information that lenders, investors,regulators, and risk managers can use consistently across communities.

Understanding mortgage risk begins with the borrower.Understanding it completely requires understanding place.

Measuring the borrower transformed mortgage underwriting.Measuring place will similarly transform the way mortgage risk is understood.

Janus: Looking Back, Looking Forward

The Romans represented transitions with the god Janus, whosetwo faces looked simultaneously to the past and the future. Few images bettercapture the way I now think about mortgage risk.

Looking back has always been an essential part of thejourney. Every research project began by trying to understand evidence from thepast—housing booms and busts, changing urban structure, mortgage defaults, andfinancial crises. Those experiences revealed how places evolve, how uncertaintyshapes economic decisions, and why mortgage performance differs so dramaticallyfrom one community to another.

But understanding the past was never the ultimate objective.

Every mortgage is a decision about the future.

Lenders, investors, and homeowners are not primarilyconcerned with yesterday's appraisal or last year's default rate. They aremaking decisions whose consequences will unfold over years, sometimes decades.The central question is not simply what happened. It is what is most likely tohappen next.

That realization ultimately shaped the design of ForeScore.

Traditional mortgage analysis asks whether today's borrowerqualifies for today's loan. Traditional appraisals estimate the current valueof the collateral. Both remain essential. But neither is designed to evaluatehow the environment surrounding that mortgage is likely to evolve over time.

ForeScore™ begins from a different premise. Mortgageperformance emerges from the interaction between borrowers and place. Placeencompasses the evolving economic, demographic, social, health, neighborhood,and housing market conditions that shape both collateral and borrower behaviorthroughout the life of a mortgage.

Because the future is uncertain, no single forecast can everbe sufficient. A useful framework should allow lenders and investors to exploremultiple futures under different economic, demographic, and housing marketassumptions. The objective is not to eliminate uncertainty, but to understandhow uncertainty changes mortgage risk under alternative scenarios.

In that sense, ForeScore™ is not just about predicting thelikely future, but also about asking better questions.

How does mortgage risk change if economic growth slows? Whathappens if migration accelerates? How will mortgage performance respond ifhousing supply expands more rapidly than demand? Which communities are likelyto remain resilient, and which are more vulnerable to changing economic,demographic, or health conditions?

These are not questions that can be answered by examining anappraisal or a credit score alone.

They require understanding the place in which the mortgageexists.

Good risk management is not about predicting the future withcertainty.

It is about being prepared for more than one future.

When I bought my first home in Vancouver, I was trying tounderstand how the economics of one mortgage could change so dramatically insuch a short period of time.

Decades later, I believe the answer remains remarkablysimple.

The mortgage did not change.

The place did.

The future of mortgage risk analysis lies in understandinghow the two interact over time.

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