Even if the principal value of a home stays the same, lower monthly instalments can significantly reduce mortgage default risk in the US, according to new research from the Federal Reserve Bank of New York.
The authors Paul Willen and Andreas Fuster based their findings on the performance of Alt A adjustable-rate mortgages from 2008 to 2011. This loan type benefited from the US Federal Reserve’s huge rate-cutting campaigns and its other efforts to reduce long-term borrowing costs.
“Interest rate changes dramatically affect repayment behaviour. Our estimates imply that cutting a borrower’s payment in half reduces his hazard of becoming delinquent by about two-thirds,” they said.
“Government or lender programs that allow underwater borrowers to refinance at a lower rate, or loan modifications that lower the interest rate, have the potential to significantly reduce delinquencies, and the view that principal reduction is the only way to meaningfully reduce defaults is incorrect.”
Moreover, the research findings go against the belief that once a mortgage is sufficiently far underwater, it is always optimal for the borrower to default.
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