Home shoppers aren’t the only ones who feel the impact of changing home prices. In fact, according to recent research, residential mortgage backed securities (RMBS) investors should be watching home prices just as expectantly. However, while home shoppers might delight in falling home prices, RMBS investors should not.
“The impact of price declines on default rates is very strong and consistent across a variety of different locations and corresponding home price levels,” according to a research paper published this week by Collateral Analytics.
Of course, price declines are not the only cause of default. Job loss, medical expenses, and business losses are also potential threats, according to Collateral Analytics. However, “a total loss of equity is a critical component of any default model,” according to the research.
When examining data from various metro areas from 2005 through 2018, the researchers found the strongest correlation between home price declines and mortgage defaults in Boston and the least correlation in Washington, D.C.
Seattle and Los Angeles demonstrated somewhat typical correlations between home price declines and mortgage default rates. When home price declines accelerated by more than 10 percentage points, mortgage default rates increased an additional 7.2 percent in Seattle. In Los Angeles, defaults rose by an additional 5.0 percent under the same circumstances.
Across all of the core based statistical areas observed, Collateral Analytics determined the relationship between default rates and peak to trough price declines of -0.74.
However, when peak to trough prices declined by more than 20 percent, Collateral Analytics found default rates climbed “significantly.”
“It is not clear if homeowners are aware of small price declines, but they seem very aware of large price declines,” the research stated.
Those who purchase their home at the peak of a price cycle are more likely to default, regardless of other personal circumstances, such as employment.
This was especially the case for loans with high loan-to-value (LTV) ratios.
In fact, Collateral Analytics asserted that its research confirms “why conservative loans will be at 80% LTV or below.”