For many, homeownership is a vital part of the American dream. Buying a home represents one of the largest lifetime expenditures for most homeowners, and the mortgage has generally become the financing instrument of choice. For many families, their mortgage will be their greatest debt and their mortgage payment will be their largest recurring monthly expense.

In this report, we present a combination of new analysis and previous findings from the JPMorgan Chase Institute body of housing finance research to answer important questions about the role of liquidity, equity, income levels, and payment burden as determinants of mortgage default. Our analysis suggests that liquidity may have been a more important predictor of mortgage default than equity, income level, or payment burden.

We find:

  • Finding 1: Borrowers with little post-closing liquidity defaulted at a considerably higher rate than borrowers with at least three mortgage payment equivalents of post-closing liquidity.
  • Finding 2: Borrowers with little liquidity but more equity defaulted at considerably higher rates than borrowers with more liquidity but less equity.
  • Finding 3: Default closely followed a loss of liquidity regardless of the homeowner’s equity, income level, or payment burden.
  • Finding 4: Homeowners with fewer than three mortgage payment equivalents of liquidity defaulted at higher rates regardless of income level or payment burden.
  • Finding 5: Mortgage modifications that increased borrower liquidity reduced default rates, whereas modifications that increased borrower equity but left them underwater did not impact default rates.

 

Bar graph describes 3-year default rates, share of mortgages, and share of defaults by post-closing liquidity

Source: JPMorgan Chase Institute

3-year default rates, share of mortgages, and share of defaults by post-closing liquidity

Line graph of three-year default rates by amount of post-closing liquidity, shown against a bar chart representing the share of mortgages and share of defaults by amount of post-closing liquidity. Amount of post-closing liquidity is shown as the number mortgage payment equivalents (MPEs) a borrower has one month after closing. Borrowers with less than one MPE of post-closing liquidity defaulted at a rate (1.8%) that was more than five times higher than borrowers with between three and four MPEs of liquidity (0.3%). At higher liquidity levels, the relationship between post-closing liquidity and default rates was nearly flat: borrowers with between four and ten MPEs of liquidity had default rates between 0.2% and 0.3%. Borrowers with little in post-closing liquidity made up a disproportionately high share of defaults; those with less than one MPE in post-closing liquidity made up 20 percent of our sample but accounted for 54 percent of defaults.

Source: JPMorgan Chase Institute

Taken together, our findings suggest that a program encouraging borrowers to make a slightly smaller down payment and use the residual cash to fund an “emergency mortgage reserve” account might lead to lower default rates. A pilot program could test the impact of an emergency mortgage reserve account on default rates and, if impactful and cost-effective, the program could serve as an alternative to underwriting standards based on measuring the borrower’s static ability-to-repay using their total debt-to-income ratio at origination.

Authors

Diana Farrell

Founding and Former President & CEO

Kanav Bhagat

Director of Financial Markets Research | JPMorgan Chase Institute

Chen Zhao

Housing Finance Research Lead