Including Terminated Loans

For the regressions in Section 3 we used as dependent variable the probability that a loan of a particular age is delinquent or in foreclosure, conditional on the loan not being terminated (prepaid or defaulted) before that age. Since the focus in this paper is on young loans (age below 24 months), we do not expect terminations to play an important role for the questions we address. We confirm in this subsection that our main results are robust to explicitly taking into account terminations.

The fraction of loans that terminate in the first 12 months is 10%, 13%, 14%, 17%, 14%, 13% for 2001-2006 vintage loans respectively. This fraction peaks in 2004, during the heyday of the house price boom, which created favorable refinancing opportunities. Remarkably, it is lowest for vintage 2001 loans, which were originated prior to interest rate declines. This result might be particular for loans of age below 24 months. For hybrid mortgage loans many refinances may occur at or after the moment of the rate reset, which is typically at a loan age of 24 or 36 months.21

We re-estimate the results presented in Table 3—analyzing the effects of loan characteristics, borrower characteristics, and economic circumstances on the probability of delinquency and foreclosure—but this time include loans that are terminated prior to the moment of loan performance evaluation.

Specifically, we define a delinquent loan as a loan that 12 months after origination is either delinquent

20One reason why investors did not massively start to avoid or short subprime-related securities is that the timing of the subprime market downturn may have been hard to predict. Moreover, a short position is associated with a high cost of carry (Feldstein (2007)).

21Gabaix, Krishnamurthy, and Vigneron (2007) argue that the risk associated with mortgage prepayments is priced in the mortgage-backed securities market.

(or in foreclosure, or real estate owned), or terminated due to default. We define a loan terminated due to default when the month prior to termination the loan was in foreclosure or real-estate owned. Similarly, the new definition for foreclosure is that a loan is in foreclosure (or real estate owned), or terminated due to default. Using this alternative definitions for delinquency and foreclosure, all explanatory variables we use in the regression (see Table 3) have the same sign and remain statistically significant, except for the ARM dummy. The mortgage rate, FICO score, the CLTV ratio, and the subsequent house price appreciation remain the most important explanatory variables, measured by the absolute size of the marginal effect.

In Figure 10 we plot the actual delinquency rate (left panel) and adjusted delinquency rate (right panel) based on the definition above that includes terminated loans. In general the delinquency rate is somewhat lower than based on the baseline case definition of delinquency, in particular at older loan ages, see left panels of Figures 1 and 2 (left panel). Terminations due to a refinancing will lower the delinquency rate compared to the baseline case. Terminations due to a default have the opposite effect. Hence we find that the refinancing effect dominates the default effect. Importantly, both for the actual and the adjusted delinquency rate the order of the lines for the different vintage years remain unchanged. We again have the result that the adjusted delinquency rate has been steadily rising over the past six years.

Figure 10: Actual and Adjusted Delinquency Rates, Including Terminated Loans

The figure shows the actual delinquency rates (left panel) and adjusted delinquency rates (right panel) including terminated (prepaid and defaulted) loans for the different vintage years. Delinquency is defined as being 60 days or more late with the monthly mortgage payment, in foreclosure, real-estate owned or defaulted. Foreclosure is defined as being in foreclosure or real-estate owned or defaulted. The corresponding figures that exclude terminated loans are Figure 1 (left panel) for the actual delinquency rates and Figure 2 (left panel) for the adjusted delinquency rates.

1614121086420-

Actual Delinquency Rate, Including Terminations (%)

Adjusted Delinquency Rate, Including Terminations (%)

2006 2005 2004 2003 2002 2001

20 22 24

20 22 24

1086 4 20-

Adjusted Delinquency Rate, Including Terminations (%)

1086 4 20-

2 4 6 8 10 12 14 16 18 20 22 24 Age (Months)
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