The UFA Default Risk Index for the third quarter of 2013 rose to 114 from last quarter’s revised 96 in University Financial Associates' baseline scenario. Under current economic conditions, investors and lenders should expect defaults on loans currently being originated to be 14 percent higher than the average of similar loans originated in the 1990s, due solely to the local and national economic environment. That’s a key finding of the latest UFA Mortgage Report by University Financial Associates of Ann Arbor, Michigan.
“Most of the increased risk this quarter can be attributed to the hefty increase in mortgage rates—100 basis points in just three months! Borrowers initiating mortgages at these higher rates will have higher payment ratios and will be more likely to default if the household is stressed,” said Dennis Capozza, who is the Dale Dykema Professor of Business Administration in the Ross School of Business at the University of Michigan, and a founding principal of UFA. “At the same time, borrowers at the lower rates of earlier vintages become less likely to default. This is because their existing mortgage at the earlier favorable rate becomes a more valuable contract, since the market value of the mortgage liability falls when valued at current higher rates.”
The UFA Default Risk Index measures the risk of default on newly originated prime and nonprime mortgages. UFA’s analysis is based on a “constant-quality” loan, that is, a loan with the same borrower, loan and collateral characteristics. The Index reflects only the changes in current and expected future economic conditions, which are much less favorable currently than in prior years.