A Dynamic Look at Subprime Loan Performance

Danis, Michelle A.; Pennington‐Cross, Anthony

doi:10.20955/wp.2005.029

Cited by 20 publications

(18 citation statements)

References 18 publications

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“…However, in certain populous states with recourse, generous homestead-exemption laws can make it virtually impossible for lenders to collect on deficiency judgments because borrowers can easily shield their assets, e.g., Florida and Texas Ghent and Kudlyak (2009). study the effect of lender recourse on mortgage defaults across the U.S. and conclude that recourse does decrease the probability of default for homeowners who have negative equity.2 See, for example,Danis and Pennington-Cross (2005),Downing, Stanton and Wallace (2005),Gerardi, Shapiro and Willen (2007),Doms, Furlong, and Krainer (2007),Bajari, Chu and Park (2008),Bhardwaj and Sengupta (2008a), andGerardi et al (2008).…”

mentioning

confidence: 99%

Systemic Risk and the Refinancing Ratchet Effect

Khandani¹,

Lo²,

Merton³

2009

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The confluence of three trends in the U.S. residential housing market-rising home prices, declining interest rates, and near-frictionless refinancing opportunities-led to vastly increased systemic risk in the financial system. Individually, each of these trends is benign, but when they occur simultaneously, as they did over the past decade, they impose an unintentional synchronization of homeowner leverage. This synchronization, coupled with the indivisibility of residential real estate that prevents homeowners from deleveraging when property values decline and homeowner equity deteriorates, conspire to create a "ratchet" effect in which homeowner leverage is maintained or increased during good times without the ability to decrease leverage during bad times. If refinancing-facilitated homeowner-equity extraction is sufficiently widespread-as it was during the years leading up to the peak of the U.S. residential real-estate market-the inadvertent coordination of leverage during a market rise implies higher correlation of defaults during a market drop. To measure the systemic impact of this ratchet effect, we simulate the U.S. housing market with and without equity extractions, and estimate the losses absorbed by mortgage lenders by valuing the embedded put-option in non-recourse mortgages. Our simulations generate loss estimates of $1.5 trillion from June 2006 to December 2008 under historical market conditions, compared to simulated losses of $280 billion in the absence of equity extractions.

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confidence: 99%

Systemic Risk and the Refinancing Ratchet Effect

Khandani¹,

Lo²,

Merton³

2009

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“…In order to extract wealth there must first be some equity in the house. However, low equity has also been shown to reduce the ability of both prime and subprime borrowers to refinance regardless of the cash-out status (Pennington-Cross 2003, Danis andPennington-Cross 2005). Since low-equity will deter both non-cash-out and cash-out refinances, it is an empirical question whether equity extraction is deterred more than typical refinances.…”

Section: Housing and Mortgage Characteristicsmentioning

confidence: 99%

“…For example, subprime loans are less responsive to changes in interest rates than prime loans, while prepaying more often when it is out of the money (rising interest rates). In addition, loans that have been delinquent over long periods of time tend to prepay instead of default and show relatively high default correlation rates in the most expensive segments of the market (Alexander et al 2002, Cowan and Cowan 2004, Pennington-Cross 2003, and Danis and Pennington-Cross 2005.…”

Section: Termination Characteristics Of Cash-out Refinance Loansmentioning

confidence: 99%

Subprime Refinancing: Equity Extraction and Mortgage Termination

Chomsisengphet¹,

Pennington‐Cross²

2006

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This paper examines the choice of borrowers to extract wealth from housing in the highcost (subprime) segment of the mortgage market while refinancing and assesses the prepayment and default performance of these cash-out refinance loans relative to the rate refinance loans. Consistent with survey evidence the propensity to extract equity while refinancing is sensitive to interest rates on other forms of consumer debt. After the loan is originated, our results indicate that cash-out refinances perform differently from noncash-out refinances. For example, cash-outs are less likely to default or prepay, and the termination of cash-outs is more sensitive to changing interest rates and house prices.

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“…However, these studies did not observe the monthly outstanding balance on the loan and used only the amortization schedule to update the outstanding balance in each month. Because of the high rate of delinquency (Danis and Pennington-Cross, 2005) of subprime loans this approach would lead to an overestimate of the equity in the home. The measure of CLTV used in this paper corrects for this problem by using the actual outstanding loan balance in each month instead of the amortization schedule.…”

Section: Motivations To Defaultmentioning

confidence: 99%

Loan Servicer Heterogeneity and the Termination of Subprime Mortgages

Pennington‐Cross

2006

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After a mortgage is originated the borrower promises to make scheduled payments to repay the loan. These payments are sent to the loan servicer, who may be the original lender or some other firm. This firm collects the promised payments and distributes the cash flow (payments) to the appropriate investor/lender. A large data set (loan-level) of securitized subprime mortgages is used to examine if individual servicers are associated with systematic differences in mortgage performance (termination). While accounting for unobserved heterogeneity in a competing risk (default and prepay) proportional hazard framework, individual servicers are associated with substantial and economically meaningful impacts on loan termination.

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A Dynamic Look at Subprime Loan Performance

Cited by 20 publications

References 18 publications

Systemic Risk and the Refinancing Ratchet Effect

Systemic Risk and the Refinancing Ratchet Effect

Subprime Refinancing: Equity Extraction and Mortgage Termination

Loan Servicer Heterogeneity and the Termination of Subprime Mortgages

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