Trading Equity for Liquidity: Bank Data on the Relationship between Liquidity and Mortgage Default

Farrell, Diana, Kanav Bhagat, and Chen Zhao. 2019. "Trading Equity for Liquidity: Bank Data on the Relationship between Liquidity and Mortgage Default." JPMorgan Chase Institute.

28 Pages Posted: 5 Jul 2019

See all articles by Diana Farrell

Diana Farrell

JP Morgan Chase & Co. - JP Morgan Chase Institute

Kanav Bhagat

JP Morgan Chase & Co. - JP Morgan Chase Institute

Chen Zhao

JPMorgan Chase Institute

Date Written: June 27, 2019

Abstract

For many families, homeownership is a vital part of the American dream, and their mortgage will be their greatest debt and their mortgage payment will be their largest recurring monthly expense. This report aims to answer important questions about the role of liquidity, equity, income levels, and payment burden as determinants of mortgage default using a unique data set of JPMorgan Chase customers with a Chase mortgage and Chase deposit accounts. Our analysis suggests that liquidity may have been a more important predictor of mortgage default than equity, income level, or payment burden. Borrowers with little post-closing liquidity defaulted at a considerably higher rate than borrowers with at least three mortgage payment equivalents of liquidity after closing. During the life of their mortgage, borrowers with little liquidity but more equity defaulted at considerably higher rates than borrowers with more liquidity but less equity. Trading equity for liquidity at origination by making a slightly smaller down payment and holding the residual cash in an “emergency mortgage reserve” account may lead to lower default rates. A policy or pilot program could test the impact of this trade-off and, if impactful and cost-effective, the program could serve as an alternative to underwriting standards based on meeting a total debt-to-income (DTI) threshold at origination.

Keywords: mortgage, mortgage default, liquidity, household leverage, financial regulation

JEL Classification: G18, D14, G21

Suggested Citation

Farrell, Diana and Bhagat, Kanav and Zhao, Chen, Trading Equity for Liquidity: Bank Data on the Relationship between Liquidity and Mortgage Default (June 27, 2019). Farrell, Diana, Kanav Bhagat, and Chen Zhao. 2019. "Trading Equity for Liquidity: Bank Data on the Relationship between Liquidity and Mortgage Default." JPMorgan Chase Institute.. Available at SSRN: https://ssrn.com/abstract=3413995

Diana Farrell

JP Morgan Chase & Co. - JP Morgan Chase Institute ( email )

New York, NY
United States

Kanav Bhagat (Contact Author)

JP Morgan Chase & Co. - JP Morgan Chase Institute ( email )

New York, NY
United States

Chen Zhao

JPMorgan Chase Institute ( email )

601 Pennsylvania Avenue NW
Washington, DC 20004
United States

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