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March 2, 2015

The mortgage market can tolerate twice as much credit risk

March 2, 2015

The Housing Finance Policy Center in December introduced a new measure of mortgage credit availability—the Credit Availability Index or HCAI. Today, we are releasing the results of our most recent HCAI analysis on loans made during the first three quarters of 2014.

The HCAI measures the amount of default risk taken by the mortgage market at origination for owner-occupied, purchase loans and how much of that risk is due to loan type or borrowers’ credit risk.

From 2013 to Q3 2014 credit availability continued to fall, increasing the need to safely expand the credit box. The market could have taken twice the default risk it took and still remained well within the cautious standards of 2001–2003. We define the probability of default as the probability that the loan will go 90-days delinquent. Every loan that goes 90-days delinquent  does not necessarily go into foreclosure and liquidation. And if the loan is liquidated, the actual loss will be a fraction of the defaulted amount.

The newest HCAI analysis also shows that in the first three quarters of 2014, there was no change in the mortgage market’s post-crisis over-correction. There was instead a continued absence of loans with risky terms and reluctance by lenders to accept any real borrower risk.

Tighter credit from 2013-2014

Five percent of all the mortgages originated in the first three quarters of 2014 are likely to go into default under conditions weighted over all typical economic scenarios. Loans originated between 2010 and 2013 had a likely default rate of 6.4 percent under the same set of economic conditions, indicating further credit tightening in 2014 compared with the previous four years.

Significant space to safely expand the credit box

Loans originated between 2001 and 2003, a time of balanced credit access and default risk, had a likely default rate of 12.4 percent under the same set of economic conditions. The likelihood of default due just to borrower risk was 9.1 percent, while the amount attributable to product risk was 3.4 percent. Given the complete absence of risky products in today’s market, even doubling the most recent 5 percent default risk would keep the risk well within the cautious standards of 2001–2003.

The data sources

The updates of the first three quarters of the HCAI uses eMBS Inc’s loan-level data for all agency originations, including all GSE and Ginnie Mae loans. For the rest of the market, we use CoreLogic’s PLS and Servicing loan-level database to calculate the distributions of the borrower and loan characteristics. HCAI for the whole mortgage market are the weighted average of the amount of the default risk taken by each market weighted by their quarterly origination volumes, which are obtained from eMBS data and Inside Mortgage Finance. For details of the calculation of HCAI, see our paper.

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