A dynamic look at subprime loan performance

This paper examines the implications of delinquency on the performance of subprime mortgages. Specifically, we examine whether delinquency has any predictive power of the future performance of a mortgage. Using a sample of subprime mortgages from the Loan performance database on securitized private-label pool collateral, we utilize a two-step estimation procedure to control for the endogeneity of delinquency in an estimation of default and prepayment probabilities. We find strong support for the *distressed prepayment* theory that very delinquent loans are more likely to prepay than to default and that the rate of increase of prepayment is substantially larger as delinquency intensity increases. Delinquency predominately leads to termination of a loan through prepayment while negative equity leads to termination through default.