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The past, present, and future of subprime mortgages

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  • Shane M. Sherlund
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    Abstract

    This paper models the historical default and prepayment behavior for subprime mortgages using data on securitized mortgages originated from 2000 to 2007. I find that more recently originated subprime loans are more likely to default, well ahead of their first mortgage rate resets, and less likely to prepay (i.e., refinance). This rise in mortgage defaults stems largely from unprecedented declines in house prices, along with slack underwriting and tight credit market conditions. I estimate a competing hazards model to quantify the effects of (1) house price appreciation, (2) underwriting standards, (3) mortgage rate resets, and (4) household cash flow shocks, such as job loss and oil price increases, on the likelihood of borrowers with subprime mortgages to default or prepay. Ultimately, I find that borrower leverage is one of the most important factors explaining both default and prepayment for borrowers with subprime mortgages. Then, using several different assumptions about the future path of house prices, I simulate potential trajectories for subprime mortgage defaults between 2008 and 2010. Further, I explore the short-term sensitivities of default and prepayment to house prices and various mortgage characteristics.

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    Bibliographic Info

    Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2008-63.

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    Date of creation: 2008
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    Handle: RePEc:fip:fedgfe:2008-63

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    Related research

    Keywords: Subprime mortgage ; Default (Finance);

    This paper has been announced in the following NEP Reports:

    References

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    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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    1. Paul S. Willen & Adam Hale Shapiro & Kristopher Gerardi, 2008. "Subprime Outcomes: Risky Mortgages, Homeownership Experiences, and Foreclosures," 2008 Meeting Papers 345, Society for Economic Dynamics.
    2. Christopher Mayer & Karen Pence & Shane M. Sherlund, 2009. "The Rise in Mortgage Defaults," Journal of Economic Perspectives, American Economic Association, vol. 23(1), pages 27-50, Winter.
    3. Chris Mayer & Karen Pence, 2008. "Subprime mortgages: what, where, and to whom?," Finance and Economics Discussion Series 2008-29, Board of Governors of the Federal Reserve System (U.S.).
    4. Christopher J. Mayer & Karen Pence, 2008. "Subprime Mortgages: What, Where, and to Whom?," NBER Working Papers 14083, National Bureau of Economic Research, Inc.
    5. Christopher J. Mayer & Karen M. Pence & Shane M. Sherlund, 2008. "The rise in mortgage defaults," Finance and Economics Discussion Series 2008-59, Board of Governors of the Federal Reserve System (U.S.).
    6. Christopher J. Mayer & Tomasz Piskorski & Alexei Tchistyi, 2010. "The Inefficiency of Refinancing: Why Prepayment Penalties Are Good for Risky Borrowers," NBER Working Papers 16586, National Bureau of Economic Research, Inc.
    7. Benjamin J. Keys & Tanmoy Mukherjee & Amit Seru & Vikrant Vig, 2010. "Did Securitization Lead to Lax Screening? Evidence from Subprime Loans," The Quarterly Journal of Economics, MIT Press, vol. 125(1), pages 307-362, February.
    8. Bucks, Brian & Pence, Karen, 2008. "Do borrowers know their mortgage terms?," Journal of Urban Economics, Elsevier, vol. 64(2), pages 218-233, September.
    9. Atif Mian & Amir Sufi, 2008. "The Consequences of Mortgage Credit Expansion: Evidence from the 2007 Mortgage Default Crisis," NBER Working Papers 13936, National Bureau of Economic Research, Inc.
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    Cited by:
    1. Christopher Foote & Kristopher Gerardi & Lorenz Goette & Paul Willen, 2010. "Reducing Foreclosures: No Easy Answers," NBER Chapters, in: NBER Macroeconomics Annual 2009, Volume 24, pages 89-138 National Bureau of Economic Research, Inc.
    2. Taylor D. Nadauld & Shane M. Sherlund, 2009. "The role of the securitization process in the expansion of subprime credit," Finance and Economics Discussion Series 2009-28, Board of Governors of the Federal Reserve System (U.S.).
    3. Kristopher Gerardi & Lorenz Goette & Stephan Meier, 2010. "Financial literacy and subprime mortgage delinquency: evidence from a survey matched to administrative data," Working Paper 2010-10, Federal Reserve Bank of Atlanta.

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