This paper studies loss given default using a large set of historical loan-level default and recovery data of high loan-to-value residential mortgages from several private mortgage insurance ...companies. We show that loss given default can largely be explained by various characteristics associated with the loan, the underlying property, and the default, foreclosure, and settlement process. We find that the current loan-to-value ratio is the single most important determinant. More importantly, mortgage loss severity in distressed housing markets is significantly higher than under normal housing market conditions. These findings have important policy implications for several key issues in Basel II implementation.
Most US house price models break down in the mid-2000s, due to the omission of exogenous changes in mortgage credit supply (associated with the sub-prime mortgage boom) from house priceto-rent ratio ...and inverted housing demand models. Previous models lack data on credit constraints facing first-time home-buyers. Incorporating a measure of credit conditions — the cyclically adjusted loan-to-value ratio for first-time buyers - into house price-to-rent ratio models yields stable long-run relationships, more precisely estimated effects, reasonable speeds of adjustment and improved model fits.
The Rise in Mortgage Defaults Mayer, Christopher; Pence, Karen; Sherlund, Shane M.
The Journal of economic perspectives,
2009, Volume:
23, Issue:
1
Journal Article
Peer reviewed
Open access
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.
During the recent financial crisis, ABX.HE index credit default swaps (CDS) on baskets of mortgage-backed securities were a benchmark widely used by financial institutions to mark their subprime ...mortgage portfolios to market. However, we find that prices for the AAA ABX.HE index CDS during the crisis were inconsistent with any reasonable assumption for mortgage default rates, and that these price changes are only weakly correlated with observed changes in the credit performance of the underlying loans in the index, casting serious doubt on the suitability of these CDS as valuation benchmarks. We also find that the AAA ABX. HE index CDS price changes are related to short-sale activity for publicly traded investment banks with significant mortgage market exposure. This suggests that capital constraints, limiting the supply of mortgage-bond insurance, may be playing a role here similar to that identified by Froot (2001) in the market for catastrophe insurance.
Choosing a mortgage is one of the most important financial decisions made by a household. Financial innovation has given rise to more complex mortgage products with back-loaded payments, known as ...‘Alternative Mortgage Products’ (AMPs), or ‘Interest-Only Mortgages’. Using a specially designed question module in a representative survey of UK mortgage holders, we investigate the effect of consumer financial sophistication on the decision to choose an AMP instead of a standard repayment mortgage. We show poor financial literacy and present bias raise the likelihood of choosing an AMP. Financially literate individuals are also more likely to choose an Adjustable Rate Mortgage (ARM), suggesting they avoid paying the term premium of a fixed rate mortgage.
Price Dispersion in Mortgage Markets Allen, Jason; Clark, Robert; Houde, Jean-François
The Journal of industrial economics,
September 2014, Volume:
62, Issue:
3
Journal Article
Peer reviewed
Open access
Using transaction-level data on Canadian mortgage contracts, we document an increase in the average discount negotiated off the posted price and in rate dispersion. Our aim is to identify the ...beneficiaries of discounting and to test whether dispersion is caused by price discrimination. The standard explanation for dispersion in credit markets is risk-based pricing. Our contracts are guaranteed by governmentbacked insurance, so risk cannot be the main factor. We find that lenders set prices that reflect consumer bargaining leverage, not just costs. The presence of dispersion implies a lack of competition, but our results show this to be consumer specific.
Mortgage loans are leading examples of transactions where experts on one side of the market take advantage of consumers'lack of knowledge and experience. We study the compensation that borrowers pay ...to mortgage brokers for assistance from application to closing. Two findings support the conclusion that confused borrowers overpay for brokers' services: (i) A model of effective shopping shows that borrowers sacrifice at least $1,000 by shopping from too few brokers, (ii) Borrowers who compensate their brokers with both cash and a commission from the lender pay twice as much as similar borrowers who pay no cash.
Institutions often offer a menu of contracts to consumers in an attempt to create a separating equilibrium that reveals borrower types and provides better pricing. We test the effectiveness of a ...specific set of contracts in the mortgage market: mortgage points. Points allow borrowers to exchange an upfront amount for a decrease in the mortgage rate. We document that, on average, points takers lose about $700. Also, points takers are less financially savvy (less educated, older), and they make mistakes on other dimensions (e.g., inefficiently refinancing their mortgages). Overall, our results show that borrowers overestimate how long they will stay with the mortgage.
A Model of Mortgage Default CAMPBELL, JOHN Y.; COCCO, JOÃO F.
The Journal of finance (New York),
August 2015, Volume:
70, Issue:
4
Journal Article
Peer reviewed
In this paper, we solve a dynamic model of households' mortgage decisions incorporating labor income, house price, inflation, and interest rate risk. Using a zero-profit condition for mortgage ...lenders, we solve for equilibrium mortgage rates given borrower characteristics and optimal decisions. The model quantifies the effects of adjustable versus fixed mortgage rates, loan-to-value ratios, and mortgage affbrdability measures on mortgage premia and default. Mortgage selection by heterogeneous borrowers helps explain the higher default rates on adjustable-rate mortgages during the recent U.S. housing downturn, and the variation in mortgage premia with the level of interest rates.
We document that contractual disclosures by intermediaries during the sale of mortgages contained false information about the borrower's housing equity in 7-14% of loans. The rate of misrepresented ...loan default was 70% higher than for similar loans. These misrepresentations likely occurred late in the intermediation and exist among securities sold by all reputable intermediaries. Investors—including large institutions—holding securities with misrepresented collateral suffered severe losses due to loan defaults, price declines, and ratings downgrades. Pools with misrepresentations were not issued at a discount. Misrepresentation on another easy-to-quantify dimension shows that these effects are a conservative lower bound.
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