Why mortgage defaults don't help predict a housing correction
Mortgage delinquencies refer to when a borrower falls behind on their mortgage payments.
Low delinquencies are often cited as evidence to critique predictions of a housing correction, but those arguments are flawed.
Falling house prices contribute to increased mortgage delinquencies, and this makes delinquencies a lagging indicator. Delinquencies begin trending upward six months to a year after house prices drop.
Why are delinquencies a lagging indicator?
There are several reasons why mortgage delinquencies are a lagging indicator of falling house prices:
After a run-up in prices, borrowers often have significant home equity. If they run into financial trouble they are likely able to refinance their home to continue making payments for a period even if the value of their home has declined since the market peak.
Mortgage terms often have fixed interest rates for a set period of time, which means that borrowers may be able to continue making payments even if the value of their home has declined or interest rates have increased.
As long as the current value of a home is greater than the purchase price, people in financial distress can sell their home and keep the capital gains if they fall into hard times. There is no need to default. In a worst-case scenario, they only need the current market value to be higher than the remaining balance on the mortgage.
Finally, it can take time for financial difficulty to impact mortgages. People will stop paying credit cards and car loans before they allow themselves to fall behind on their mortgage payments. Even when homeowners miss mortgage payments, the bank won’t report it as delinquent until the borrowers missed their payment for three consecutive months.
Overall, large drops in house prices usually lead to an increase in mortgage delinquencies, there are often several factors that delay the impact of falling house prices on mortgage delinquencies, making it a lagging indicator.
