A new white paper by Gopal “Sharath” Sharathchandra, the SVP of Financial Solutions for Ventera, entitled “How High Will Mortgage Defaults Go? Lessons from the 2007 Recession” forecasts the impact of the recent decline in home prices and the effects it might have on the mortgage market.
According to Sharathchandra, price declines are likely to mirror those seen in 2007, but across a larger cross-section of the country. But unlike 2007, when it was high home prices that made homes unaffordable, today it is both home prices and mortgage rates, which have recently eclipsed the 7% mark for the first time in over 20 years. The national nature of mortgage rates has contributed to a geographically broader increase in house prices and is now likely to make the decline in house prices similarly so.
“The post-2007 mortgage default data does not support the argument made by a number of economists that, even if house prices were to decline steeply, there is little likelihood of mortgage defaults being anything similar to the post-2007 experience because of stronger underwriting and better borrower financial conditions today,” said Sharathchandra. “Rather, the data indicates that the biggest driver of mortgage defaults is falling house prices and the negative equity that results from it and that this, by far, outweighs the contribution of borrower and underwriting characteristics such as FICO scores or subprime status.”
Data from Fannie Mae and Freddie Mac showed that even the low-risk portion of the prime mortgage portfolio contributed 40% of total credit losses with the overall prime portfolio contributing nearly 70%. Today’s prime portfolio is arguably higher risk, due to higher loan-to-values, and has a greater volume of vulnerable borrowers than did the 2007 prime portfolio, raising the potential for even bigger losses today if a house price decline comparable to 2007 was to occur.