Wednesday, April 16, 2008

Fed's Yellen: House Price Declines are Best Predictor of Delinquency Rates

by Calculated Risk on 4/16/2008 11:50:00 AM

San Francisco Fed President Janet Yellen repeated an earlier speech today: The Economy: Where Are We and What Will Happen Next?.

This section is worth repeating:

[R]esearch ... reveals that the single best predictor of subprime delinquency rates is the pace of house price changes. ...

The link between house prices and delinquency rates is not surprising. When house prices have been stagnant or declining, a borrower with a recent mortgage secured with a very small or no down payment has little, if any, equity in the house and, therefore, can’t rely on it to help weather income and wealth stresses like job loss, illness, or divorce. Moreover, though some borrowers may be able to afford their loans, they may decide just to walk away, if, for example, their house is worth less than their mortgage.

I should also note that, while default rates for prime loans are lower than for subprime loans, delinquency rates among all categories are highly correlated with house price declines across the country, whether borrowers are prime or nonprime, or whether loans have fixed or variable rates.
emphasis added
Now that house prices are falling rapidly in many areas, delinquency rates can be expected to increase sharply for all loan categories; prime or subprime, fixed or variable.