Written By: Joel Palmer, Op-Ed Writer
Mortgage lenders should evaluate how much cash a potential borrower has to make payments more than the size of their down payment, according to research released last week.
A JPMorgan Chase Institute report showed that borrowers with at least three months available to pay their mortgages were far less likely to default than other borrowers. This trend applied to mortgagees at all income levels.
“Our findings show that liquidity may have been a more important predictor of default than equity, income level, or payment burden, especially for those borrowers with little liquidity,” read the report. “Specifically, borrowers with little post-closing liquidity defaulted at a considerably higher rate than borrowers with at least three mortgage payment equivalents of liquidity after closing. Furthermore, during the life of their mortgage, borrowers with little liquidity but more equity defaulted at considerably higher rates than borrowers with more liquidity but less equity.
Details of the research include:
•Borrowers whose cash on hand was less than the amount of their mortgage payment at closing defaulted on their loans five times more than those with three to four months of liquidity.
•Homeowners with less than one mortgage payment equivalent (MPE) of post-closing liquidity made up 20 percent of clients sampled. But they accounted for 54 percent of defaults.
•Borrowers with less equity but more cash reserves at origination have lower default rates than those with little liquidity.
The report also suggested that “underwriting standards that rely on meeting a debt-to-income threshold at origination may not be the most effective method for reducing mortgage default.”
Its research showed that defaults were often preceded by a drop in the borrower’s income regardless of DTI at origination.
The report also showed that mortgage modifications that increased borrower liquidity reduced default rates. Those that increased borrower equity and left them underwater did not impact default rates.
Specifically, a 10 percent payment reduction that helps with liquidity reduced default rates by 22 percent.
“A financially distressed homeowner could use an emergency mortgage reserve account to provide themselves with a temporary payment reduction in the same way a mortgage modification would, through increased liquidity,” read the report. “Funded with three to four MPEs of liquidity, an emergency mortgage reserve account could provide a distressed homeowner with a 25 to 33 percent payment reduction for one year and help them avoid default.”
The report, titled Trading Equity for Liquidity: Bank Data on the Relationship between Liquidity and Mortgage Default, was based on an analysis of Chase customers with both mortgages and accounts through the bank.
“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.”
About the Author
As an NAMP® Opinion Editorial Contributor, Joel Palmer is a freelance writer who spent 10 years as a business and financial reporter and another 10 years in marketing for the insurance and financial services industries. He regularly writes about the mortgage industry, as well as residential and commercial real estate, investments, and retirement income planning. He has also ghostwritten books on starting a business, marketing, and retirement income planning.