The Impact of Positive Payment Shocks on Mortgage Credit Risk – A Natural Experiment from Home Equity Lines of Credit at End of Draw
49 Pages Posted: 20 May 2016
Date Written: May 18, 2016
Using a unique loan-level residential home equity data from the largest US mortgage servicers that contains a large number of loan attributes and borrower characteristics, we find that default risk of home equity lines of credit (HELOCs) increases with the size of positive payment shocks. Furthermore, default risk increases at end of draw (EOD) when borrowers first experience liquidity constraints and cannot refinance under tightened lending standards. Our findings are robust across different model specifications and risk segments, using clustered standard errors and controlling for the sample selection bias from HELOC payoffs prior to EOD. Since an unprecedented number of HELOCs are expected to reach their EOD period in 2016-2017, we provide several prudential recommendations for lenders and regulators. These include (i) capturing payment shocks and liquidity constraints in credit risk models, (ii) smoothing payment shocks in contract designs as well as work out process, and (iii) coordination in loosening or tightening HELOC lending standards.
Keywords: Default, End of Draw, Home Equity Lines of Credit, Lending Standards, Payment Shock, Payoff, Refinance, Utilization
JEL Classification: G2, C3
Suggested Citation: Suggested Citation