While nonprime lending has experienced steady if not explosive growth over the last decade very little is known about the performance characteristics of these mortgages. Private data vendors publish estimates that nonprime mortgages default and prepay at elevated levels, but no published research (as far as the author is aware) exists on the performance of nonprime mortgages.
Using data from Fannie Mae and Freddie Mac, this paper estimates a competing risks proportional hazard model popularized by McCall (1996). The analysis examines the performance 30 year fixed rate mortgages from February 1995 to the end of 1999 and compares nonprime and prime loan default and prepayment behavior. Nonprime loans are identified by relatively higher mortgage interest rates.
Results indicate that nonprime borrowers do not have the same risk characteristics as prime borrowers at origination, default and prepay at elevated levels, and respond differently to the incentives to prepay and default. For example, model results indicate that in the 28 th month of the loan the conditional monthly probability of defaulting is 0.098% for typical nonprime borrower and 0.012% for the typical prime borrower. The typical conditional monthly probability of prepaying is also estimated as 3.12% for nonprime and 2.44% for prime borrowers.
While on average nonprime borrowers do prepay at a higher rate, the model results indicate that prepayment rates of nonprime borrowers are less responsive to how much the option to call the mortgage or refinance is in the money but are more responsive to credit scores. Default rates of nonprime borrowers are also less responsive to homeowner equity than prime borrowers.
In summary, the findings of this paper confirm that nonprime borrowers are generally more likely to prepay and default. However, the econometric findings indicate that the extent of those relative tendencies vary substantially and (with respect to prepayments) may be reversed depending on loan age, credit scores, down payments, interest rates, house prices, and labor market conditions.
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Patterns of Default and Prepayment for Prime and Nonprime Mortgages
