Mortgage Delinquencies
The recent sharp increase in subprime mortgage delinquencies has captured the public spotlight and led analysts to search for the factors that are likely to have contributed to the problem. These factors commonly include the lack of income documentation, high loan-to-income ratios, the lowering of credit standards, and the resets on adjustable-rate loans, to name but a few. Although these factors are important to consider, it also is important to remember that the delinquencies have occurred during a time of seismic shifts in the patterns of house-price appreciation, shifts that were unprecedented in terms of their size and suddenness and that varied widely across metropolitan areas.
In this Letter, we explore how the pace of and change in house-price appreciation can affect the incentives and opportunities for borrowers in a market to avoid delinquencies and foreclosures. For instance, with likely gains in home equity in markets where house prices have risen significantly, a homeowner should have greater incentives and opportunities to keep a mortgage loan current. Indeed, we show that markets that recently experienced greater house-price appreciation tended to have lower delinquency rates and smaller increases in delinquency rates. We also find that metropolitan areas where house prices decelerated the most in 2006 have experienced the largest increases in subprime delinquency rates. One of several possible explanations for this relationship is that, in the face of sharp declines in the pace of house-price appreciation, some borrowers may have lowered their expectations about future appreciation rates, and, hence, the attractiveness of the investment component of homeownership also declined.
The subprime market
One hurdle facing researchers in the subprime market area is that there is no readily agreed upon definition of "subprime." Indeed, the subprime residential mortgage market barely existed in 1995, although since then it has grown rapidly, by some estimates accounting for approximately 20% of all first lien mortgages made in 2006. Generally speaking, subprime is a lender-given designation for borrowers with low credit scores (FICO score less than 620, for example), with little credit history, or with other types of observable credit impairment.
Although "subprime" is not rigorously and consistently defined in the mortgage industry, one firm, First American LoanPerformance (FALP), has produced a number of statistics on regional delinquency rates based on subprime mortgages in its database. The delinquency rate is defined as the percent of subprime loans that are delinquent 60 days or more. The data, which are from 2005 and 2006, contain observations on 309 metropolitan statistical areas (MSAs), and form the basis of our analysis (see also The Wall Street Journal 2007). It is worth noting that the FALP data do not represent the entire universe of mortgages; also, estimates of delinquency rates on subprime mortgages vary among sources, reflecting differences in the definition of subprime and sample coverage. However, where possible, we have compared the FALP data to those from other sources and have found high correlations among them.
The FALP data show considerable regional variation in the delinquency rates and in the changes in the delinquency rates. The median delinquency rate in 2006 among the 309 MSAs was 12.2%, with a range from about 3% to 25%. MSAs near the Gulf Coast that were severely affected by Hurricane Katrina were among those with the highest delinquency rates. Overall, however, the MSAs with the highest delinquency rates tend to be located in the Midwest; of the 18 MSAs with the highest subprime delinquency rates in 2006, 14 were in Michigan or Ohio.
In terms of changes in subprime delinquency rates, nearly all MSAs posted increases from 2005 to 2006. The median change was about 3 percentage points, and the largest increase was 11 percentage points. Of the 309 MSAs in the sample, only 25 had decreases in their delinquency rates, with the sharpest declines among MSAs near the Gulf Coast. Of the 18 MSAs that posted the largest increases in delinquency rates, 12 were in California and 3 were in Massachusetts. These MSAs typically had relatively low delinquency rates at the end of 2005.
