Payment size, negative equity, and mortgage default

Abstract: Surprisingly little is known about the importance of mortgage payment size for default, as efforts to measure the treatment effect of rate increases or loan modifications are confounded by borrower selection. We study a sample of hybrid adjustable-rate mortgages that have experienced substantial rate reductions over the past years and are largely immune to these selection concerns. We find that payment size has an economically large effect on repayment behavior; for instance, cutting the required payment in half reduces the delinquency hazard by about 55 percent. Importantly, the link between payment size and delinquency holds even for borrowers who are significantly underwater on their mortgages. These findings shed light on the driving forces behind default behavior and have important implications for public policy.

Keywords: adjustable-rate mortgages; delinquency; mortgage finance; Alt-A;

JEL Classification: E43; G21;

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Bibliographic Information

Provider: Federal Reserve Bank of New York

Part of Series: Staff Reports

Publication Date: 2015-01-01

Number: 582

Pages: 61 pages