Mortgage Default Risk Drops to Lowest Level in Seven Years

March 5, 2012 at 8:52 AM
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Low mortgage rates and monetary policy lowered the UFA Default Risk Index for the first quarter of 2012, which has now reached its lowest level since 2005, before the housing bust.

Now at 128, the index fell from last quarter's revised 129. Under current economic conditions, investors in mortgage backed securities and lenders should expect defaults on loans currently being originated to be only be 28 percent higher than the average of similar loans originated in the 1990s, due solely to the local and national economic environment.

"Our baseline macro scenario is based on consensus expectations and has real GDP growing at 2.5 percent for the next two years and core inflation at 1.6 percent. We believe that surprises are more likely to be on the upside than the downside of this consensus," said Dennis Capozza, who is the Dale Dykema Professor of Business Administration in the Ross School of Business at the University of Michigan, and a founding principal of UFA. "Upside surprises for the macro scenario would reduce defaults relative to this baseline. Currently, record low mortgage rates and accommodative monetary policy are helping to support the housing market and reduce defaults relative to what would otherwise prevail."

The UFA Default Risk Index measures the risk of default on newly originated prime and nonprime mortgages. UFA's analysis is based on a "constant-quality" loan, that is, a loan with the same borrower, loan and collateral characteristics. The Index reflects only the changes in current and expected future economic conditions, which are much less favorable currently than in prior years.

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