IDEAS home Printed from https://ideas.repec.org/a/eee/juecon/v93y2016icp60-70.html
   My bibliography  Save this article

Payment changes and default risk: The impact of refinancing on expected credit losses

Author

Listed:
  • Tracy, Joseph
  • Wright, Joshua

Abstract

This paper analyzes how access to credit and the path of mortgage rates can affect borrower credit risk. This is a crucial issue for evaluating refinance programs as a form of loss mitigation, and it became prominent in the debates around the Treasury Department's Home Affordable Refinance Program (HARP). These debates exposed gaps in the literature on the relationship between credit performance and changes in borrowers’ monthly mortgage payments. Since then, several new studies have attempted to fill these holes, each pursing a different methodology. In this paper, we review the relevant debates and look at what downward adjustments in prime adjustable-rate mortgages can tell us about modifications of prime fixed-rate mortgages. We argue that this method better addresses the various sampling biases that plague all attempts to predict HARP's impact. Our analysis indicates that typical monthly payment reductions under HARP would reduce credit losses by 56 basis points.

Suggested Citation

  • Tracy, Joseph & Wright, Joshua, 2016. "Payment changes and default risk: The impact of refinancing on expected credit losses," Journal of Urban Economics, Elsevier, vol. 93(C), pages 60-70.
  • Handle: RePEc:eee:juecon:v:93:y:2016:i:c:p:60-70
    DOI: 10.1016/j.jue.2016.03.007
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0094119016000279
    Download Restriction: Full text for ScienceDirect subscribers only

    As the access to this document is restricted, you may want to look for a different version below or search for a different version of it.

    Other versions of this item:

    References listed on IDEAS

    as
    1. Dhillon, Upinder S & Shilling, James D & Sirmans, C F, 1987. "Choosing between Fixed and Adjustable Rate Mortgages: A Note," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 19(2), pages 260-267, May.
    2. Brent W. Ambrose & Michael LaCour-Little & Zsuzsa R. Huszar, 2005. "A Note on Hybrid Mortgages," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 33(4), pages 765-782, December.
    3. Luigi Guiso & Paola Sapienza & Luigi Zingales, 2009. "Moral and Social Constraints to Strategic Default on Mortgages," Economics Working Papers ECO2009/27, European University Institute.
    4. Qi, Min & Yang, Xiaolong, 2009. "Loss given default of high loan-to-value residential mortgages," Journal of Banking & Finance, Elsevier, vol. 33(5), pages 788-799, May.
    5. Foote, Christopher L. & Gerardi, Kristopher & Willen, Paul S., 2008. "Negative equity and foreclosure: Theory and evidence," Journal of Urban Economics, Elsevier, vol. 64(2), pages 234-245, September.
    6. Anthony Pennington-Cross & Giang Ho, 2010. "The Termination of Subprime Hybrid and Fixed-Rate Mortgages," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 38(3), pages 399-426.
    7. Yongheng Deng & John M. Quigley & Robert Van Order, 2000. "Mortgage Terminations, Heterogeneity and the Exercise of Mortgage Options," Econometrica, Econometric Society, vol. 68(2), pages 275-308, March.
    8. Richard K. Green & James D. Shilling, 1997. "The Impact of Initial-Year Discounts on ARM Prepayments," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 25(3), pages 373-385.
    9. Meyer, Bruce D, 1990. "Unemployment Insurance and Unemployment Spells," Econometrica, Econometric Society, vol. 58(4), pages 757-782, July.
    10. Caplin, Andrew & Freeman, Charles & Tracy, Joseph, 1997. "Collateral Damage: Refinancing Constraints and Regional Recessions," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(4), pages 496-516, November.
    11. Andrew Haughwout & Ebiere Okah & Joseph Tracy, 2016. "Second Chances: Subprime Mortgage Modification and Redefault," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 48(4), pages 771-793, June.
    12. Brent W. Ambrose & Michael LaCour-Little, 2001. "Prepayment Risk in Adjustable Rate Mortgages Subject to Initial Year Discounts: Some New Evidence," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 29(2), pages 305-327.
    13. Brueckner, Jan K & Follain, James R, 1988. "The Rise and Fall of the ARM: An Econometric Analysis of Mortgage Choice," The Review of Economics and Statistics, MIT Press, vol. 70(1), pages 93-102, February.
    14. Agarwal, Sumit & Amromin, Gene & Ben-David, Itzhak & Chomsisengphet, Souphala & Evanoff, Douglas D., 2010. "Market-Based Loss Mitigation Practices for Troubled Mortgages Following the Financial Crisis," Working Paper Series 2010-19, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. repec:rsr:supplm:v:65:y:2017:i:5:p:122-138 is not listed on IDEAS
    2. Therese C. Scharlemann & Stephen H. Shore, 2015. "The Effect of Negative Equity on Mortgage Default: Evidence from HAMP PRA," Working Papers 15-06, Office of Financial Research, US Department of the Treasury.
    3. Johnson, Kathleen W. & Sarama, Robert F., 2015. "End of the Line: Behavior of HELOC Borrowers Facing Payment Changes," Finance and Economics Discussion Series 2015-73, Board of Governors of the Federal Reserve System (US).
    4. Hancock, Diana & Passmore, Wayne, 2016. "Cost of funds indexed mortgage contracts with government-backed catastrophic insurance (COFI-Cats): A realistic alternative to the 30-year fixed-rate mortgage?," Journal of Economics and Business, Elsevier, vol. 84(C), pages 109-130.
    5. Andreas Fuster & Paul S. Willen, 2017. "Payment Size, Negative Equity, and Mortgage Default," American Economic Journal: Economic Policy, American Economic Association, vol. 9(4), pages 167-191, November.
    6. Beraja, Martin & Fuster, Andreas & Hurst, Erik & Vavra, Joseph, 2015. "Regional heterogeneity and the refinancing channel of monetary policy," Staff Reports 731, Federal Reserve Bank of New York, revised 01 Mar 2018.
    7. Benjamin J. Keys & Tomasz Piskorski & Amit Seru & Vincent Yao, 2014. "Mortgage Rates, Household Balance Sheets, and the Real Economy," NBER Working Papers 20561, National Bureau of Economic Research, Inc.
    8. Epouhe, Onesime & Hall, Arden, 2016. "Payment shock in HELOCs at the end of the draw period," Journal of Economics and Business, Elsevier, vol. 84(C), pages 131-147.
    9. Karamon, Kadiri & McManus, Douglas & Yannopoulos, Elias, 2016. "Spillover effects of continuous forbearance mortgages," Journal of Economics and Business, Elsevier, vol. 84(C), pages 95-108.
    10. repec:hur:ijaraf:v:8:y:2018:i:2:p:37-47 is not listed on IDEAS
    11. Lee, Donghoon & Tracy, Joseph, 2018. "Long-term outcomes of FHA first-time homebuyers," Staff Reports 839, Federal Reserve Bank of New York.
    12. Abel, Joshua & Fuster, Andreas, 2018. "How do mortgage refinances affect debt, default, and spending? Evidence from HARP," Staff Reports 841, Federal Reserve Bank of New York.
    13. repec:kap:jrefec:v:55:y:2017:i:4:d:10.1007_s11146-016-9566-z is not listed on IDEAS
    14. Danne, Christian & McGuinness, Anne, 2016. "Mortgage modifications and loan performance," Research Technical Papers 05/RT/16, Central Bank of Ireland.
    15. Joanne W. Hsu & David A. Matsa & Brian T. Melzer, 2014. "Positive Externalities of Social Insurance: Unemployment Insurance and Consumer Credit," NBER Working Papers 20353, National Bureau of Economic Research, Inc.

    More about this item

    Keywords

    Mortgages; Refinancing; Default; HARP;

    JEL classification:

    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • R51 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Regional Government Analysis - - - Finance in Urban and Rural Economies

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:juecon:v:93:y:2016:i:c:p:60-70. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Dana Niculescu). General contact details of provider: http://www.elsevier.com/locate/inca/622905 .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.