The most important article you can read this weekend is economist Stan Leibowitz’s analysis of loan level data on 30 million mortgages. His conclusion is straight-forward: the most important driver of foreclosures is homeowner equity. This means that the loans most likely to default are high loan to value, low-down payment loans.
Equally arresting is the list of things we’ve come to associate with the boom that make very little difference on foreclosures. Subprime lending–nope. Teaser rates–not the problem. Liar loans–just move along. Predatory loans–sorry, kids.
It’s the low down payments.
The analysis indicates that, by 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. The accompanying figure shows how important negative equity or a low Loan-To-Value ratio is in explaining foreclosures (homes in foreclosure during December of 2008 generally entered foreclosure in the second half of 2008). A simple statistic can help make the point: although only 12% of homes had negative equity, they comprised 47% of all foreclosures.
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.
This has serious policy implications. It suggests that programs aimed at lower a borrower’s monthly payments may not have all that much influence on stemming foreclosures. And it indicates that stronger under writing standards might be the key to avoiding another foreclosure crisis down the road.
So now we should be asking: how did we wind up with so many low down payment, high LTV mortgages?
Business Insider Emails & Alerts
Site highlights each day to your inbox.