When America spun into the recession the
default rate on mortgages also spiraled up from traditional norms of 0 to 2
percent to as high as 10 percent of all mortgages and in some markets and for
certain loans, over 25 percent.
While default allowed many borrowers to
get out from under heavy housing costs and others to escape from mortgages that
were underwater, default is far from positive for most borrowers and many
perceive it to be very costly, losing equity and access to credit. There has not been much research into these
costs however, so the most recent Economic Letter from the Federal Reserve Bank
of San Francisco looks at how long it takes persons or households that default
on a mortgage to return to home ownership.
William Hedberg, a research associate and
John Krainer a senior economist at the bank looked at Equifax's consumer loan
data from the first quarter of 1999 to the fourth quarter of 2011, defining a
mortgage default as one that was either 120 days past due or marked "severely
derogatory" meaning past due and with a charge-off or foreclosure. They then looked at when those borrowers
again had access to credit. The
researchers did not attempt to determine if the borrower might not desire
credit nor did they differentiate between lender decisions about granting
credit and institutional restrictions such as those put in place by the
government sponsored enterprises (GSEs) that do not preclude but put up a
powerful barriers to returning to the market.
The data show that a prior mortgage
default has a large effect on future access to mortgage credit. Figure 1 shows the rate at which borrowers
with different credit histories return to the mortgage market after they exited
it. Those who had a zero mortgage
balance after having a positive one (whether through amortization, trading up,
or moving) without a default return to the market at a highly accelerated rate
compared to those who exited through a default.
While some non-defaulters like those who have paid off their mortgages
might never return to the market, the study found that 35 percent had taken out
new mortgages within the 12 years covered by the study while only about 15
percent had returned to the market after a default.
Figure 2 shows the rates at which
borrowers who defaulted on mortgages in 2001, 2003, or 2008 returned to the
market. The figure plots the cumulative percentage of defaulters who have a new
mortgage within a given number of quarters after their last default. Even
though a short amount of time has passed since the 2008 cohort defaulted, their
return to the housing market appears to be significantly slower than for
cohorts that defaulted in the two earlier years. The low rate of return for the
2008 cohort could be related to demand. In the 2001 and 2003 cohorts, there was
very strong overall demand for housing, as evidenced by the strong run-up in
the rate of homeownership during the 2000s. But the Great Recession that began
in 2007 was much deeper than the 2001 recession, and uncertainty about jobs or
future income prospects may have made people unwilling or unable to demand
housing at the rate seen after previous recessions.
The slow return evidenced in the
group that defaulted in 2008 (and 2009 and 2010 cohorts which look very
similar) could also reflect the tight credit supply. The credit environment for the 2001 and 2003
cohorts was very different in the years after their defaults. Loan terms were
generally easy and subprime mortgage lending boomed. The economic picture was much brighter in the
earlier period as well, but even in the good times of 2001 and 2003 it took a
long time for borrowers to return to the housing market after default and about
two-thirds of the 2001 group had still not done so after ten years.
Figure 3 looks at defaulted
borrowers by credit score using borrowers' first scores after taking out the
loans on which they ultimately defaulted.
Borrowers with the higher scores are labeled as prime borrowers by the
authors and the lower score borrowers as subprime.
The two groups in the years
immediately following foreclosure had similar experiences, probably because the
prime borrowers were no longer prime; their credit scores had been badly
damaged. But after about two years the
prime borrowers began to return as a far faster rate than those that were
subprime even though the majority of prime borrowers did not return during the
The authors expected there might be
a distinction in their study between borrowers who defaulted in judicial or in
non-judicial foreclosure states because the judicial foreclosures are most
costly and time consuming. All else being
equal, they say, borrowers in judicial states would be expected to be denied
credit for longer periods. While there
was a distinction, it was not large.
What explains the low return of
defaulted borrowers to the market? The
authors found that overall economic conditions such as local unemployment rates
and past house appreciation appear to play an important role, but the best
predictor was the change in the borrowers' credit score. The research found that, after five years,
borrowers who return to the mortgage market after a default have experienced a
more-than-100 point increase in their score.
In conclusion Hedberg and Krainer say that the process of regaining creditworthiness is
lengthy. Borrowers who terminated their mortgages for reasons other than
default returned to the market about two-and-a-half times faster than those who
defaulted. "This has important implications for the housing recovery. The
improvement in the housing market is often assumed to reflect significant
pent-up demand. But an estimated 4 million foreclosures have taken place since
2007. The consumers who went through those foreclosures will return to
homeownership only gradually, suggesting that mortgage supply will also be a
factor in the housing recovery."