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What’s an Acceptable Level of Mortgage Default?

Vintage Year Analysis Reveals Room to Loosen Underwriting

Molly Boesel    |    Mortgage Performance

There will always be some amount of delinquency in the mortgage market, but what is an acceptable level? At its worst during the housing crisis, the serious delinquency (SDQ)1 rate was 8.6 percent in February 2010. Recently, CoreLogic reported that there were 1.6 million SDQ mortgages in the U.S.—a rate of 4.2 percent of all active mortgages. Overall, the SDQ rate is on the decline, and a look beneath the surface shows that while loans originated from 2004 to 2008 drove the SDQ rate higher, loans originated in the past four years are among the most pristine loans made in the past 15 years. Does this low level of delinquency for the most recent originations indicate that credit standards have been tightened too far?

CoreLogic typically reports the SDQ rate for all outstanding mortgages, but not all origination years are created equal. For example, as shown in Figure 1, while the overall SDQ rate is 4.2 percent, some origination years have experienced much higher delinquency rates, driving the overall rate. Of the active loans at the end of September 2014, originations made between 2004 and 2008 accounted for about 77 percent of total SDQ mortgages, and account for about 25 percent of active mortgages. Excluding these origination years, the SDQ rate is currently 2.1 percent.

Recent Vintages Exhibit Pristine Performance

Recent Vintages Exhibit Pristine Performance

Another way to look at SDQ rates is by the year in which they were originated, otherwise known as vintage curves or default fingers, which control for or remove time-varying effects and offer a cleaner view of mortgage performance for loans originated in different years. Figure 2 shows the SDQ rates for three to 60 months after origination for the vintage years from 1999 to 2013, with 2010 to 2013 only showing partial vintage curves. The figure is split into three panels to help illustrate how differently the various vintages perform, with 1999 to 2003 in the first panel, 2004 to 2008 in the second panel, and 2009 to 2013 in the third panel.

Among the vintage years 1999 to 2003, the peak SDQ rate was 5.7 percent for the 2000 vintage year, but all other vintage years in this group showed SDQ rates of roughly 2 percent or less throughout the five-year period after origination. Paid-off loans exacerbate the delinquency problems with the 2000 vintage because the average mortgage rate that year was 8.05 percent, and many borrowers refinanced over the following four years. By month 48 of performance for the 2000 vintage, as SDQ rates were reaching 5.5 percent, only 12 percent of the originations were still active. The borrowers left over-represent those that were unable to refinance due to credit or employment problems. The second panel highlights the housing boom years and beginning of the housing bust, with SDQ rates up to nearly 18 percent for the worst performing vintages. Finally, the third panel gives a view of the post-bust vintage years. Only one of the post-bust vintages has a full five-year vintage curve, but it appears that except for 2010, which included the first-time homebuyer tax credit, these vintage years will have a peak SDQ rate of 2 percent or less.

Recent Vintages Best Performing Since 1990s

Recent Vintages Best Performing Since 1990s

Figure 3 shows a 12-month snapshot of vintage year performance, illustrating that mortgage performance problems can be seen in the worst-performing vintages at early stages. Removing those vintage years, it is easy to see that mortgages originated since 2009 are among the best-performing.

While it is tempting to blame the terrible performance of the worst vintages on exotic mortgage products, overall loose credit standards, poor economic conditions, and the housing market crash that left borrowers with negative equity are also to blame for poor performance. To demonstrate this more clearly, Figure 4 shows the “plain vanilla” type of mortgage: owner-occupied, fully-documented, 30-year fixed-rate, conventional conforming purchase mortgage with a mid-to-high credit score and moderate loan-to-value ratios2. While the level of SDQ rate shifts a bit lower for the plain vanilla mortgage than for mortgages overall, the impact is minimal, and the 2005 to 2008 vintage years still show outsized SDQ rates. Therefore, while shrinking the credit box had an impact on the mortgage performance of the post-bust originations, overall better economic conditions and improving housing market conditions have also played a role in improved delinquencies.

Plain Vanilla Performance

Plain Vanilla Performance

Do mortgage vintages really need to be as pristine as they have been in the most recent years? While there are many factors besides loan performance that should be considered in the policy decisions around access to credit, it is clear that mortgage originations made in the mid-2000s are still driving the SDQ rate, and originations made since 2009 are performing much better. Originations from 2009 to 2014 make up 62 percent of active loans, but only 15 percent of SDQs. It is also clear that even when controlling for certain elements of risk, the mid-2000 vintages still have high SDQ rates relative to the last few years.

What remains to be seen is what will happen with the economy, since even with good underwriting borrowers can still fall behind on payments due to economic distress. Given that forecasts for the economy and unemployment rate indicate slow and steady improvement and for house prices to continue to increase at a moderate pace, the excellent performance of current mortgage vintages gives some support to the notion that underwriting could be loosened in a responsible manner that still supports sustainable homeownership.

[1] Serious delinquency rate is defined as 90 days or more past due, including those loans in foreclosure or REO.

[2] Credit scores from 680 to 740, LTV less than or equal to 80 percent, fully documented, owner-occupied, fixed-rate 30-year purchase mortgages.

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