Mortgages currently being originated stand a 14 percent higher risk of default due solely to current economic conditions, especially rising mortgage interest rates and falling underwriting standards.
Under current economic conditions, investors and lenders should expect defaults on loans currently being originated to be 14% higher than the average of similar loans originated in the 1990s, due solely to the local and national economic environment.
Investors and lenders should expect defaults to rise on new loans according to the latest UFA Mortgage Report by University Financial Associates of Ann Arbor, Michigan. The UFA Default Risk Index for the third quarter of 2013 rose to 114 from last quarter’s revised 96 in our baseline scenario.
“Most of the increased risk this quarter can be attributed to the hefty increase in mortgage rates - 100bps in just three months! Borrowers initiating mortgages at these higher rates will have higher payment ratios and will be more likely to default if the household is stressed,” said Dennis Capozza, Professor of Business Administration in the Ross School of Business at the University of Michigan and a founding principal of UFA.
“At the same time, borrowers at the lower rates of earlier vintages become less likely to default. This is because their existing mortgage at the earlier favorable rate becomes a more valuable contract, since the market value of the mortgage liability falls when valued at current higher rates,” Capozza said.
Capozza also cited changes in underwriting standards as factors contributing to higher rates of risk in new mortgages. Last week Jonathan Corr, president and CEO of Ellie Mae, said credit standards continued to ease in July. “The average FICO score fell to 737, from 742 in June 2013, and it is now at the lowest level since we began our tracking in August 2011. Similarly we saw slight increases in both loan-to-value and debt-to-income ratios last month-signs that lenders are willing to accept slightly more risk to maintain volume,” he said.
The UFA Default Risk Index measures the risk of default on newly originated prime and nonprime mortgages. UFA’s analysis is based on a “constant-quality” loan, that is, a loan with the same borrower, loan and collateral characteristics. The Index reflects only the changes in current and expected future economic conditions, which are much less favorable currently than in prior years.