Tuesday, July 31, 2007

Are non-homeowners a safer lending risk in a declining house market?

With all the recent troubles in the housing market, some lenders are starting to ask whether homeowners are a higher risk than non-homeowners when lending on Prosper. In the housing market the biggest problem homeowners are facing is when ARM or adjustable rate mortgages reset at higher payments and higher interest rates after the initial one to seven-year fixed term. When combined with falling house prices, borrowers are sometimes unable to refinance their mortgage since they owe more on their house than it is worth. These borrowers are stuck with a house they cannot afford and cannot sell for the amount of their mortgage and are forced into foreclosure. Because of these deteriorating market conditions, some lenders have started asking borrowers whether they are in a fixed mortgage or whether they have adjustable rate mortgages (or ARMs). Others have taken to the forums to list the reasons they won't invest in loans related to real estate deals.

To get an idea of how the stats look in Prosper, I pulled one year of Prosper Marketplace data for loans from March 28, 2006 through March 28, 2007. Four months have passed since the end of the data range which gives all of the loans a chance at going late. Auto-fund loans were also excluded from this data. Here is a table that shows default rates for home owners vs default rates for non-homeowners for this one year time period.

Credit Grade
Homeowner Defaults
Non-Homeowner Defaults
AA
0.81%
0.58%
A
3.23%
1.29%
B
5.10%
3.46%
C
9.12%
6.58%
D
12.93%
7.52%
E
16.75%
20.79%
HR
29.49%
41.89%


What this data suggests is that homeowners in Prime or near-Prime credit grades have higher default rates than non-homeowners. In the sub-prime markets homeowners are actually a better risk than non-homeowners. This data came as a surprise to me. With all the news about problems in the sub-prime mortgage industry I had assumed that sub-prime homeowners would be at an increased risk for default.

Personally I don't pay too much attention to home ownership as a criteria when deciding whether or not to fund a loan. Without being able to see the terms of the mortgage or the borrower's equity position, it is difficult to gage what effect the mortgage will have on the ability to repay the Prosper loan. Some borrowers will include this information in the description of the loan or in answers to questions. However, there is no verification of the information in those sections, so I do not trust that it is accurate. It would be too easy for the borrowers to write what they thought the lenders want to hear - especially in answers to leading questions.

In the higher credit grades the higher default rate might be partially compensated for by the difference in the amount of money recovered in debt sales for defaulted loans. When these sales have occurred, loans for homeowners at higher credit grades have been sold for as much as 25 or 30 cents on the dollar compared to pennies on the dollar for non-homeowners. Also, with this data being from the very early stages of the house market decline it may be too soon to tell what the overall effect will be on the Prosper marketplace.

4 comments:

thisguy said...

I take it into consideration, but less on grade and more on location. i.e. I'd much rather lend to a borrower in CA than a homeowner. Reason? Renting is generally 800 - 1200. Many homeowners in CA have mtg payments of 2400-3500. That scares me, no matter what the income. Its a lot easier fitting 800-1200 into any budget than 3000.

As for the subprime home owner vs non home owner, both default rates are atrocious. :) So its a moot point. What are the raw numbers, how many funded HRs even had homes? I'd argue its probably a small number versus HRs who rent. In theory it should be difficult to obtain a mortgage if you have such low credit. Granted that was blown out of the water the past 3-4 years but pre 2001 it was....

Matt said...

Yes, that's true - I also avoid Es and HR loans - homeowner or not. I think HRs would have a very hard time becoming a homeowner right now.

Their only chance would be to buy the house while they had good credit, and then have something like a divorce or medical bills mess up their credit while still a home owner.

Mike said...

My concern is that homeowners are more likely to do stupid financial things to keep their home. My view is that if the phrase "real-estate" or "help me keep my home" is the the listing description, run.

Mike

Tom said...

Mike, you make a great point. I followed your link - nice article on real estate.

What surprised me is that homeowners period were more likely to default, even if the loan has nothing to do with their house. I would have expected just the opposite.