The effect of changing mortgage payments on default and prepayment: Evidence from HAMP resets

Abstract

After 5 years of subsidy, interest rates for mortgages modified under the Home Affordable Modification Program (HAMP) reset, increasing annually in increments of up to 1 percentage point until they reach a predetermined rate. We identify the causal effect of increasing interest rates on default, delinquency, and prepayment using an event study design and confirm the effects using a regression kink design. New delinquency and default spike at time of reset among those whose rates increase, with smaller persistent effects continuing. These delinquency and default effects are smaller for lower balance loans in the second reset, for which additional subsidies at the time of second reset are relatively more valuable.We find that a 1 percentage point increase in the mortgage rate led to a roughly 20% increase in the default hazard. This implies that the reset rate increase is costeffective for lenders given the default environment at the time of reset: increased revenue from higher rates exceeds estimated losses from additional defaults.

Why Do Borrowers Default on Mortgages? A New Method for Causal Attribution

“…But if strategic default is rare because the private cost of mortgage default is high, then stringent public penalties may be unnecessary. 8 Second, our results on the lack of default driven by negative equity bolster an active literature documenting the superiority of payment reduction to principal forgiveness as a foreclosure prevention tool (Eberly and Krishnamurthy 2014;Ganong and Noel 2018;Scharlemann and Shore 2019).The policy design questions addressed in this literature may again become crucial in response to COVID-19, as April 2020 saw the largest single-month increase in mortgage delinquency ever recorded (Black Knight 2020). The contribution of this paper to that literature is to study borrowers that the previous literature classified as especially likely to default strategically.…”

Comments and Discussion

“…For example, in prior research with Peter Ganong, I have found that payment reductions more than five years in the future have no impact on default, while immediate payment reductions have large impacts on default (Ganong and Noel 2020a). Other research on the strong relationship between current payments and default includes , , Tracy and Wright (2016), , Di Maggio and others (2017), Agarwal and others (2020), Ganong and Noel (2020b), Scharlemann and Shore (2017), Ehrlich and Perry (2015), and Abel and Fuster (2021).…”