The Impact of Second Loans on Subprime Mortgage Defaults

29 Pages Posted: 17 Dec 2013

See all articles by Michael D. Eriksen

Michael D. Eriksen

University of Cincinnati - Department of Finance - Real Estate

James B. Kau

University of Georgia - Department of Insurance, Legal Studies, Real Estate

Donald C. Keenan

University of Cergy-Pontoise; University of Georgia

Multiple version iconThere are 2 versions of this paper

Date Written: Winter 2013

Abstract

An estimated 12.6% of primary mortgage loans were simultaneously originated with a second loan from 2004 until 2008, although relatively little is known about how the presence of such subordinate loans affects the default decisions of borrowers. We use a novel data series of loan servicing records from 2002 until 2010 to identify such borrowers and find evidence that the default behavior of these borrowers significantly differs from borrowers without second loans. Estimating a discrete‐time proportional odds hazard model, we find borrowers with a second loan were 62.7% more likely to default each month on their primary loan when conditioning alone on the attributes of the primary loan. However, borrowers of second loans were 58.3% less likely to default on their primary loan as compared to single‐loan borrowers with equivalent current combined attributes (i.e., loan‐to‐value, balance and interest rate). We hypothesize and provide empirical evidence that this occurs because borrowers with second loans have the option to sequentially default on each loan since subordinate lenders will not pursue foreclosure if borrowers have insufficient equity. Lenders of defaulted subordinate debt may revisit their decision to foreclose in the future after housing markets start to recover, thus prompting a new round of foreclosures.

Suggested Citation

Eriksen, Michael D. and Kau, James B. and Keenan, Donald C., The Impact of Second Loans on Subprime Mortgage Defaults (Winter 2013). Real Estate Economics, Vol. 41, Issue 4, pp. 858-886, 2013, Available at SSRN: https://ssrn.com/abstract=2368605 or http://dx.doi.org/10.1111/reec.12016

Michael D. Eriksen (Contact Author)

University of Cincinnati - Department of Finance - Real Estate ( email )

College of Business Administration
Cincinnati, OH 45221
United States

James B. Kau

University of Georgia - Department of Insurance, Legal Studies, Real Estate ( email )

Athens, GA 30602-6254
United States
706-542-9110 (Phone)
706-542-4295 (Fax)

Donald C. Keenan

University of Cergy-Pontoise ( email )

33 Boulevard du Port
Cergy-Pontoise Cedex, Cedex 95011
France

University of Georgia ( email )

510 Brooks Hall
Athens, GA 30602
United States
706-542-3668 (Phone)

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