Working Paper: NBER ID: w19345
Authors: Andreas Fuster; Paul S. Willen
Abstract: Surprisingly little is known about the importance of mortgage payment size for default, as efforts to measure the treatment effect of rate increases or loan modifications are confounded by borrower selection. We study a sample of hybrid adjustable-rate mortgages that have experienced large rate reductions over the past years and are largely immune to these selection concerns. We show that interest rate reductions dramatically affect repayment behavior, even for borrowers who are significantly underwater on their mortgages. Our estimates imply that cutting a borrower's payment in half reduces his hazard of becoming delinquent by about 55 percent, an effect approximately equivalent to lowering the borrower's combined loan-to-value ratio from 145 to 95 (holding the payment fixed). These findings shed light on the driving forces behind default behavior and have important implications for public policy.
Keywords: Mortgage Default; Payment Size; Negative Equity; Interest Rates
JEL Codes: E43; G21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| cutting a borrower's payment in half (G51) | reduces the hazard of becoming delinquent (G51) |
| lowering the borrower's combined loan-to-value (CLTV) ratio from 145% to 95% (G51) | reduces the hazard of becoming delinquent (G51) |
| a 2 percentage point reduction in the interest rate charged to a borrower (E43) | yields a similar effect on the default hazard as reducing the CLTV from 135% to 105% (G59) |
| a 3 percentage point reduction in interest rates for typical 5/1 hybrid ARMs (E43) | reduces the number of delinquencies (G51) |
| a 2 percentage point interest rate reduction (E43) | doubles the probability of a loan curing (becoming current) (G51) |