Mortgage Trends Show Credit Tightening and Rise in Strategic Default Behavior
The past five years have shown a substantial change in the mortgage industry. While exotic mortgages, no down payment/no documentation/no income verification loans, and the belief that house values could only trend up were once the norm, conditions today include falling home prices, tighter credit, regulations and wariness on the part of all players in the mortgage market. For regulators and policymakers, the challenge continues. They must understand these mortgage trends and their impact on the overall market while also setting policy to help guide our economic recovery.
In terms of mortgage trends, first mortgage originations over the past six years showed improvement in borrower creditworthiness, as exhibited in Figure 1. Borrower creditworthiness is measured using VantageScore®, a tri-bureau score that ranges from 501 to 990. VantageScores are segmented into five letter bands:
Consumers within the A to C bands are considered to have good credit quality, while consumers within the D and F bands are considered risky borrowers. While the D and F bands held approximately 25 percent of the total first mortgages originated in 2006, these bands represented only 9 percent of total originations in June 2011. On the other hand, the A band has nearly doubled during the same period, from 15 percent to 29 percent.
The number of first mortgage originations declined from approximately 200,000 to approximately 126,000 between 2006 and June 2011. In particular, the period between 2009 and June 2011 saw a proportionally larger decline in the total number of first mortgages originated by lenders.
While origination loan quality continues to improve, a key element that influences borrower payment behavior — home prices — continues to decline. Decreasing home values, combined with difficult economic conditions, drive borrowers to prioritize making timely payments to fulfill various credit obligations. While many borrowers default on their mortgage obligation due to hardship during these times, we also have observed the emergence of the strategic defaulter. Although in a secure financial position and with good credit history, the strategic defaulter decides to avoid making payments on his or her mortgage if the home’s value is lower than the mortgage on that home. These shrewd and savvy borrowers view their properties as bad investments and don’t consider sentimental value when deciding to default on the mortgage.
Additionally, in this era of loan modifications and ongoing policy developments, it is important to distinguish a strategic defaulter from other borrowers who are genuinely unable to make payments, since a strategic defaulter will likely redefault on a modified loan. Other borrower types include distressed defaulters, who default continuously on several or all of their debt obligations, including the mortgage, and cash flow managers, who default on their mortgage payment periodically while staying current on other debt obligations. Figure 2 shows that as strategic default remains high, rising from 6 percent in Q2 2006 to 17 percent in Q2 2010, the incidence of distressed default has decreased and has been replaced by cash flow managers. This is evidence that many distressed consumers are regaining their ability to make periodic payments on their mortgage loan.
A recent Experian and Oliver Wyman study resulted in the development of a clearer profile for strategic defaulters. These borrowers generally have higher incomes, own mortgages with higher origination balances, stay current on other credit obligations and are more likely to have originated a new mortgage six months prior to mortgage default.
Experian’s Strategic Default IndicatorsSM can help regulators and policymakers understand strategic default behavior and better determine the impact of this group of consumers on policy decisions and the overall market. These indicators help to identify consumers who have exhibited strategic default and cash flow manager behavior.
Experian® also has developed a new set of loan modification attributes to capture the number and type of loan modifications made and to identify those that haven’t been delinquent or derogatory. This new set of attributes is a subset of more than 800 Premier AttributesSM that capture a variety of consumer behaviors and are available to government agencies to help inform policy and make regulatory decisions.
To learn more, register to download the Experian–Oliver Wyman studies entitled Strategic defaults off from peak but still high and The Mortgage Industry’s Future: A Legislative, Industry And Analytic View
VantageScore® is owned by VantageScore Solutions, LLC.