Payment Changes and Default Risk: The Impact of Refinancing on Expected Credit Losses

34 Pages Posted: 12 Jun 2012

See all articles by Joseph S. Tracy

Joseph S. Tracy

National Bureau of Economic Research (NBER); Federal Reserve Bank of Dallas

Joshua Wright

Federal Reserve Banks - Federal Reserve Bank of New York

Date Written: June 2012

Abstract

This paper analyzes the relationship between changes in borrowers' monthly mortgage payments and future credit performance. This relationship is important for the design of an internal refinance program such as the Home Affordable Refinance Program (HARP). We use a competing risk model to estimate the sensitivity of default risk to downward adjustments of borrowers' monthly mortgage payments for a large sample of prime adjustable-rate mortgages. Applying a 26 percent average monthly payment reduction that we estimate would result from refinancing under HARP, we find that the cumulative five-year default rate on prime conforming adjustable-rate mortgages with loan-to-value ratios above 80 percent declines by 3.8 percentage points. If we assume an average loss given default of 35.2 percent, this lower default risk implies reduced credit losses of 134 basis points per dollar of balance for mortgages that refinance under HARP.

Keywords: refinancing, default

JEL Classification: G21, G18, R51

Suggested Citation

Tracy, Joseph and Wright, Joshua, Payment Changes and Default Risk: The Impact of Refinancing on Expected Credit Losses (June 2012). FRB of New York Staff Report No. 562, Available at SSRN: https://ssrn.com/abstract=2080261 or http://dx.doi.org/10.2139/ssrn.2080261

Joseph Tracy (Contact Author)

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Federal Reserve Bank of Dallas ( email )

2200 North Pearl Street
PO Box 655906
Dallas, TX 75265-5906
United States

Joshua Wright

Federal Reserve Banks - Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

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