07 July 2009

Lack Of Equity As The Primary Foreclosure Factor

[B]y far, the most important factor related to foreclosures is the extent to which the homeowner now has or ever had positive equity in a home. . . . A simple statistic can help make the point: although only 12% of homes had negative equity, they comprised 47% of all foreclosures. . . .

Causes of mortgage foreclosures, 2nd half of 2008 . . .

Negative Equity: 285,305
Down Payment of Less Than 3%: 130,014
Mortgage Rate Reset Upward: 60,942
Subprime FICO Score (<620): 148,697
Unemployment Increase In 2008: 183,447 . . .

Further, because it is difficult to account for second mortgages in this data, my measurement of negative equity and its impact on foreclosures is probably too low, making my estimates conservative.

What about upward resets in mortgage interest rates? I found that interest rate resets did not measurably increase foreclosures until the reset was greater than four percentage points. Only 8% of foreclosures had an interest rate increase of that much. Thus the overall impact of upward interest rate resets is much smaller than the impact from equity.

To be sure, many other variables — such as FICO scores (a measure of creditworthiness), income levels, unemployment rates and whether the house was purchased for speculation — are related to foreclosures. But liar loans and loans with initial teaser rates had virtually no impact on foreclosures, in spite of the dubious nature of these financial instruments.

Instead, the important factor is whether or not the homeowner currently has or ever had an important financial stake in the house. Yet merely because an individual has a home with negative equity does not imply that he or she cannot make mortgage payments so much as it implies that the borrower is more willing to walk away from the loan.

From here

The regression analysis supporting the analysis above is based upon "loan-level data from McDash Analytics, a component of Lender Processing Services Inc. It is the largest loan-level data source available, covering more than 30 million mortgages."

Others (at the same link, but with a different person quoted) argue that while loan to value was a factor, that its dominance is overstated, as other factors were also important.

MBA data from September 2008:

For prime loans, foreclosure starts on fixed rate loans were 0.34 percent, an increase of five basis points, while prime ARM foreclosure starts were 1.82 percent, a 26 basis point increase. For subprime loans, fixed rate foreclosure starts increased 27 basis points to 2.07 percent and subprime ARM foreclosure starts increased 31 basis points to 6.63 percent

Sub-prime worse than Prime, ARMs much worse than fixed.

The average loss a bank suffers when a subprime loan goes to a foreclosure sale is currently 64.7%. Thus, the loans were typically written for something close to three times what the property was actually worth, post-bubble collapse.

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