Mortgage Default and Low Downpayment Loans: The Costs of Public Subsidy

42 Pages Posted: 21 Jul 2000 Last revised: 21 Sep 2010

See all articles by Yongheng Deng

Yongheng Deng

Wisconsin School of Business, University of Wisconsin-Madison

John M. Quigley

University of California, Berkeley, College of Letters & Science, Department of Economics (Deceased); University of California, Berkeley, Haas School of Business, Real Estate Group (Deceased)

Robert Van Order

Federal Home Loan Mortgage Corporation (FHLMC) - Housing Economics and Financial Research

Date Written: July 1995

Abstract

This paper presents a unified model of the default and prepayment behavior of homeowners in a proportional hazard framework. The model uses the option-based approach to analyze default and prepayment and considers these two interdependent hazards as competing risks. The results indicate the sensitivity of default to the initial loan-to-value ratio of the loan and the course of housing equity. The latter is a measure of the extent to which the default option is in the money. The results also indicate the importance of trigger events, namely unemployment and divorce, in affecting prepayment and default behavior. The empirical results are used to analyze the costs of a current policy proposal -- stimulating homeownership by offering low downpayment loans. We simulate default probabilities and costs on zero-downpayment loans and compare them to conventional loans with conventional underwriting standards. The results indicate that if zero-downpayment loans were priced as if they were mortgages with ten percent downpayments, then the additional program costs would be two to four percent of funds made available -- when housing prices increase steadily. If housing prices remained constant, the costs of the program would be much larger indeed. Our estimates suggest that additional program costs could be between $74,000 and $87,000 per million dollars of lending. If the expected losses from such a program were not priced at all, the losses from default alone could exceed ten percent of the funds made available for loans.

Suggested Citation

Deng, Yongheng and Quigley, John M. and Van Order, Robert, Mortgage Default and Low Downpayment Loans: The Costs of Public Subsidy (July 1995). NBER Working Paper No. w5184. Available at SSRN: https://ssrn.com/abstract=225247

Yongheng Deng (Contact Author)

Wisconsin School of Business, University of Wisconsin-Madison ( email )

4110 Grainger Hall
975 University Avenue
Madison, WI 53706
United States
+1 (608) 262-4865 (Phone)

HOME PAGE: http://https://bus.wisc.edu/faculty/yongheng-deng

John M. Quigley

University of California, Berkeley, College of Letters & Science, Department of Economics (Deceased) ( email )

Berkeley, CA 94720-3880
United States
510-643-7411 (Phone)
510-643-7357 (Fax)

University of California, Berkeley, Haas School of Business, Real Estate Group (Deceased) ( email )

Berkeley, CA 94720-1900
United States

Robert Van Order

Federal Home Loan Mortgage Corporation (FHLMC) - Housing Economics and Financial Research ( email )

Mailstop 484
8200 Jones Branch Drive
McLean, VA 22102
United States
703-903-2390 (Phone)
703-903-2445 (Fax)

Register to save articles to
your library

Register

Paper statistics

Downloads
60
Abstract Views
2,422
rank
354,838
PlumX Metrics