The Rise in Mortgage Defaults

Abstract

The first hints of trouble in the mortgage market surfaced in mid-2005, and conditions subsequently began to deteriorate rapidly. Mortgage defaults and delinquencies are particularly concentrated among borrowers whose mortgages are classified as "subprime" or "near-prime." The main factors underlying the rise in mortgage defaults appear to be declines in house prices and deteriorated underwriting standards, in particular an increase in loan-to-value ratios and in the share of mortgages with little or no documentation of income. Contrary to popular perception, the growth in unconventional mortgages products, such as those with prepayment penalties, interest-only periods, and teaser interest rates, does not appear to be a significant factor in defaults through mid-2008 because borrowers who had problems with these products could refinance into different mortgages. However, as markets realized the extent of the poor underwriting, underwriting standards tightened and borrowers began to face difficulties refinancing; this dynamic suggests that these unconventional products could pose problems going forward.

Improving the 30-Year Fixed-Rate Mortgage

“…This model suggests that current COFI is 21 Negative equity is a necessary-but not sufficient-condition of mortgage default. Campbell and Cocco (2015), Gerardi et al (2015), and Mayer, Pence, and Sherlund (2009) as the mortgage principal is paid down, the premium shrinks in terms of dollars (or percent of house price). The size of the premium depends on the insurance payouts.…”

Technological Change, Financial Innovation, and Diffusion in Banking

“…Sherlund (2009) andGerardi, Lehnert, Sherlund, and among others point to a significant increase in borrower leverage during the mid2000s, as measured by combined loan-to-value (CLTV) ratios, which was soon followed by falling house prices. 6…”

Trend growth expectations and U.S. house prices before and after the crisis

“…By contrast, the ratio of household mortgage debt to the market value of owner-occupied real estate remained essentially unchanged up until the peak of (real) house prices in mid-2006, when it started rising sharply as a result of the decline in the denominator. This flat "average loan-to-value" ratio masks substantial redistribution from seasoned home owners, whose LTVs fell as their home values appreciated, to new mortgage borrowers, especially those in the subprime segment, whose LTVs rose during the boom (Mayer et al, 2009). 7 Nonetheless, it is striking that the enormous increase in household indebtedness evident from the solid line was on average not associated with an increase in the ratio of debt outstanding to collateral value.…”