Slightly reducing
down payments and saving surplus cash in a reserve account could mean lower
mortgage defaults according to a recent study.
The JPMorgan Chase Institute found that when borrowers have less
than three months’ mortgage payment equivalent (MPE) of post-closing liquidity,
their 3-year default rate (1.8%) was six times higher than those with between 3
and 4 MPE (0.3%).
The findings challenge conventional wisdom that larger down
payments cut default rates due to the lower LTV ratio; and suggests that a
program allowing homeowners to make a slightly lower down payment but bank
residual cash in a reserve account, may help cut default rates.
“Understanding the principal factors associated with mortgage
default is critically important to developing solutions that help Americans
avoid default and stay in their homes,” said Diana Farrell, President and CEO,
JPMorgan Chase Institute. “We hope this analysis is valuable in helping
mortgage lenders and servicers develop policies and programs that could prevent
defaults in the future, while also helping more people access mortgages and
have the opportunity to own a home.”
Underwriting standards
The report says that underwriting standards that rely on
debt-to-income ratio at origination do not account for potential future income
volatility and – in the analysis of Chase mortgage customers – of those who
defaulted there had been a drop in income preceding the default.
Across all levels of total DTI at origination, half of homeowners
who defaulted had fewer than 1.4 MPEs of liquidity, and the median homeowner
who did not default had more liquidity than those who did.
And a 10% reduction in payment (which could be achieved using
funds saved in a reserve account) or 10% increase in income, cut default rates
by 22%.
Mortgage modifications that increased borrower liquidity reduced
default rates, whereas modifications that increased borrower equity but left
them underwater did not impact default rates.
Source: Steve Randall (2019, July 22). Lower Down Payment, Reserve Fund Could Cut Defaults Says Study.
Canadian Real Estate Wealth
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