Falling Behind : Bank Data on the Role of Income and Savings in Mortgage Default

For many American households, buying a home is one of the largest sources of debt. We use mortgage data at the individual borrower level joined to their deposit account data to investigate the relationship between income shocks and default for borrowers with different levels of home equity, income, payment burden, and savings. First, we find that mortgage default closely followed a negative income shock regardless of a borrower's level of home equity, income, or payment burden (as measured by total debt-to-income at origination). This provides suggestive evidence against a simple model of strategic default where deeply underwater borrowers stop making mortgage payments only because they are underwater. Second, we find that deeper and longer duration negative income shocks were associated with increasing delinquency. To the extent that homeowners income recovered quickly, they promptly resumed making mortgage payments, while those who suffered longer, deeper income shocks fell further into delinquency. Third, default rates for homeowners with smaller financial buffers were higher regardless of their income level or payment burden. The default rate for borrowers with less than the one mortgage payment equivalent held in reserve was 7 times higher than the default rate for borrowers with at least four mortgage payments in reserve. Half of homeowners who defaulted had fewer than 1.4 mortgage payment equivalents held in reserves, and this was true across all levels of total DTI at origination. These findings suggest that a policy based on maintaining a minimum post-purchase financial buffer may be a better approach to default prevention than underwriting standards based on measuring the borrowers' static ability-to-repay at origination