Home Equity Indicator of Mortgage Payback Risk!!!

May 9th, 2008

Personal credit scores used to be a pretty accurate indicator of the odds that American borrowers would pay off their mortgage loans. But in the past few months–far too late to do anything about it–lenders are finding that the amount of equity people have in their homes is a better determinant for the risk of default. That is a ticking time bomb as U.S. home prices weaken in the wake of the subprime loan crisis because it means that relatively affluent borrowers might not stick around once their equity turns negative, potentially beginning a vicious circle of home abandonments that push down prices and encourage new defaults. “What the whole industry is seeing is a higher correlation between higher loan-to-value ratio and the likelihood of default,” said Terry Francisco, a vice president at Bank of America. “In previous cycles, the correlation had been between FICO scores and default,” he said. FICO scores, developed by Fair Isaac, have been widely used in determining the creditworthiness of individuals. A booming real estate market, which encouraged loose mortgage underwriting helped fuel overheated housing prices in markets like Southern Florida, Southern California, Las Vegas and Phoenix. While the problem with subprime mortgages is well known and likely to be largely played out, their upscale cousins, known as Alt-A loans, are now threatening creditors with a new default spree. Alt-A borrowers had respectable FICO scores, but they bought mortgages that did not conform to the high standards of the prime market. Often Alt-A loans were for expensive properties and were taken out by borrowers who did not care to document their income or pony up the once-standard 20.0% downpayment.

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