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Payment size, negative equity, and mortgage default

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  • Andreas Fuster
  • Paul S. Willen

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 changes dramatically affect repayment behavior. Our estimates imply that cutting a borrower’s payment in half reduces his hazard of becoming delinquent by about two-thirds, an effect that is 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.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Boston in its series Public Policy Discussion Paper with number 12-10.

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Date of creation: 2012
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Handle: RePEc:fip:fedbpp:12-10

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Keywords: Mortgage loans ; Adjustable rate mortgages ; Default (Finance);

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  1. Dean S. Karlan & Jonathan Zinman, 2005. "Observing Unobservables: Identifying Information Asymmetries with a Consumer Credit Field Experiment," Working Papers 911, Economic Growth Center, Yale University.
  2. Manuel Adelino & Kristopher Gerardi & Paul S. Willen, 2009. "Why don't lenders renegotiate more home mortgages? redefaults, self-cures, and securitization," Working Paper 2009-17, Federal Reserve Bank of Atlanta.
  3. Christopher Foote & Kristopher Gerardi & Lorenz Goette & Paul S. Willen, 2009. "Reducing foreclosures: no easy answers," Working Paper 2009-15, Federal Reserve Bank of Atlanta.
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  6. Thomas Schelkle, 2012. "Mortgage Default during the U.S. Mortgage Crisis," 2012 Meeting Papers 751, Society for Economic Dynamics.
  7. Kau, James B, et al, 1992. "A Generalized Valuation Model for Fixed-Rate Residential Mortgages," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 24(3), pages 279-99, August.
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  9. Neil Bhutta & Jane Dokko & Hui Shan, 2010. "The depth of negative equity and mortgage default decisions," Finance and Economics Discussion Series 2010-35, Board of Governors of the Federal Reserve System (U.S.).
  10. Christopher L. Foote & Kristopher S. Gerardi & Paul S. Willen, 2012. "Why Did So Many People Make So Many Ex Post Bad Decisions? The Causes of the Foreclosure Crisis," NBER Working Papers 18082, National Bureau of Economic Research, Inc.
  11. von Furstenberg, George M, 1969. "Default Risk on FHA-Insured Home Mortgages as a Function of the Terms of Financing: A Quantitative Analysis," Journal of Finance, American Finance Association, vol. 24(3), pages 459-77, June.
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  14. Joseph Tracy & Joshua Wright, 2012. "Payment changes and default risk: theimpact of refinancing on expected credit losses," Staff Reports 562, Federal Reserve Bank of New York.
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  19. Andrew Haughwout & Ebiere Okah & Joseph Tracy, 2009. "Second chances: subprime mortgage modification and re-default," Staff Reports 417, Federal Reserve Bank of New York.
  20. Andrew Haughwout & Donghoon Lee & Joseph Tracy & Wilbert van der Klaauw, 2011. "Real estate investors, the leverage cycle, and the housing market crisis," Staff Reports 514, Federal Reserve Bank of New York.
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Cited by:
  1. Andrew Haughwout & Sarah Sutherland & Joseph Tracy, 2013. "Negative equity and housing investment," Staff Reports 636, Federal Reserve Bank of New York.

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