Payment Size, Negative Equity, and Mortgage Default

Abstract

Surprisingly little is known about the importance of mortgage payment size for default, as efforts to measure the treatment effect of rate increases or loan modifications are confounded by borrower selection. We study a sample of hybrid adjustable-rate mortgages that have experienced large rate reductions over the past years and are largely immune to these selection concerns. We show that interest rate reductions dramatically affect repayment behavior, even for borrowers who are significantly underwater on their mortgages. Our estimates imply that cutting a borrower's payment in half reduces his hazard of becoming delinquent by about 55 percent, an effect approximately equivalent to lowering the borrower's combined loan-to-value ratio from 145 to 95 (holding the payment fixed). These findings shed light on the driving forces behind default behavior and have important implications for public policy.

Foreclosure Contagion and the Neighborhood Spillover Effects of Mortgage Defaults

“…The first‐stage results are substantial, suggesting that a 100 basis point increase in interest rates corresponds to a roughly 2.5% rise in the probability of experiencing a foreclosure in the subsequent 12 months—a substantial increase relative to a baseline foreclosure rate of 8%. These results are in line with existing work on mortgage resets (see, for instance, Fuster and Willen ()). I contribute to this literature by obtaining a tighter empirical setting using the within‐month variation in interest rates as a shock to the reset window.…”

The Effect of Mortgage Payment Reduction on Default: Evidence from the Home Affordable Refinance Program

“…Our findings complement recent research on the effect of payment reduction on ARM defaults, and are of a similar magnitude to those computed by Fuster and Willen () and Tracy and Wright (). Taken together, these empirical results demonstrate a material reduction in mortgage default rates in response to payment reduction.…”

“…Thus, if a HARP‐eligible loan had an expected lifetime default rate of 5% and experienced a 20% payment reduction through the refinance, the new expected default rate for the HARP refinance would be about 4%. This result is consistent with the studies of Fuster and Willen () and Tracy and Wright () on payment reduction in ARM loans and extends this area of research to a set of mortgages with potentially greater relevance to policy makers.…”

“…Recent literature examines how mortgage interest rate reductions affect repayment propensity for performing loans . Fuster and Willen () study interest‐only adjustable rate mortgages (ARMs) using a competing risk model of default and prepayment and find that a 10% reduction in payment generates a 13% reduction in default . An important limitation of their research is that it focuses on a narrow segment of the market: Interest‐only ARMs backing private‐label mortgage‐backed securities.…”

Business cycle implications of mortgage spreads

“…It is therefore a good approximation to consider the time variation in mortgage spreads studied in this paper as an "excess premium" over and above variation in the credit risk in the same spirit as Gilchrist and Zakrajšek (2012) or Meeks (2012). The reason that mortgage credit risk is only marginally a¤ecting spread variation in the US is that more than 75 percent of the prime conforming loans are guaranteed against credit risk by Fannie Mae or Freddie Mac (Fuster et al, 2012). Pricing of these guarantees is not primarily intended to capture macroeconomic variation in credit risk and has very limited (+/-5 bps) price variation within our sample period.…”