Payment Size, Negative Equity, and Mortgage Default

67 Pages Posted: 17 Aug 2013

See all articles by Andreas Fuster

Andreas Fuster

Swiss National Bank - Financial Stability

Paul Willen

Federal Reserve Bank of Boston - Research Department; National Bureau of Economic Research (NBER)

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Date Written: August 2013

Abstract

Surprisingly little is known about the importance of mortgage payment size for default, as efforts to measure the treatment effect of rate increases or loan modifications are confounded by borrower selection. We study a sample of hybrid adjustable-rate mortgages that have experienced large rate reductions over the past years and are largely immune to these selection concerns. We show that interest rate reductions dramatically affect repayment behavior, even for borrowers who are significantly underwater on their mortgages. Our estimates imply that cutting a borrower's payment in half reduces his hazard of becoming delinquent by about 55 percent, an effect approximately equivalent to lowering the borrower's combined loan-to-value ratio from 145 to 95 (holding the payment fixed). These findings shed light on the driving forces behind default behavior and have important implications for public policy.

Suggested Citation

Fuster, Andreas and Willen, Paul S., Payment Size, Negative Equity, and Mortgage Default (August 2013). NBER Working Paper No. w19345, Available at SSRN: https://ssrn.com/abstract=2311593

Andreas Fuster (Contact Author)

Swiss National Bank - Financial Stability ( email )

Boersenstrasse 15
Zurich, CH-8022
Switzerland

Paul S. Willen

Federal Reserve Bank of Boston - Research Department ( email )

600 Atlantic Avenue
Boston, MA 02210
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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