Having just three mortgage payments worth of liquidity can be enough to reduce the likelihood of foreclosure, according to research from JPMorgan Chase. Research from the JPMorgan Chase Institute indicates that cash in the bank is more important in preventing default than the size of the down payment.
Homeowners having this money in savings is also more important than the amount of home equity, the income level of the homeowners, or the size of the mortgage payment in relation to household income to prevent default. Regardless of income level or payment burden, homeowners with fewer than three mortgage payment equivalents of liquidity defaulted at higher rates.
Borrowers with less than one month of mortgage payment equivalents (MPE) defaulted at a rate of 1.8%, over five times higher than borrowers with between three and four MPEs of liquidity (0.3%). However, 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%.
Homeowners with little in post-closing liquidity made up a “disproportionately high share of defaults,” Chase notes. Homeowners with less than one MPE made up 20% of the study’s sample size, but made up 54% of defaults.
Additionally, Chase found that homeowners with a higher DTI also had a less liquidity. “ These
findings suggest that any relationship between lower total DTI at origination and lower default rates may be more closely associated with lower DTI households maintaining greater liquidity over the life of their mortgage,” Chase noted.
Equity seems to have little impact on default. Chase found that borrowers with little liquidity but more equity defaulted at considerably higher rates than borrowers with more liquidity but less equity.
“Conventional wisdom argues that larger down payments, and therefore lower loan-to-value (LTV) ratios, lead to lower default rates and smaller losses given default,” Chase states. “However, if the borrower is left with little-to-no liquidity after making a larger down payment, does conventional wisdom regarding lower default rates still apply?”
Instead, lower down payments mean more post-closing liquidity, lowering the risk of default.