Increased borrowing by homeowners against their properties is having a deleterious impact on the credit-positive effects of rising home prices on residential mortgage-backed securities (RMBS), according to a new report from Moody’s Investors Service
Moody’s noted that while current underwriting standards and operational practices will help mitigate the negative effects of this trend—especially if home prices show continue their seemingly endless increases—the risks could increase as loan products used for equity extraction regain favor.
“Rising home prices generally help lower default risk and loss severities, and therefore are credit positive for RMBS transactions,” says Peter McNally, a Moody’s analyst. “Rising prices, however, can also entice borrowers to extract equity from their homes and increase their debt load, adding risk to RMBS deals.”
McNally noted that an increase in cash-out refinancings in RMBS tied to newly originated loans—either private-label securitizations and Fannie Mae/Freddie Mac credit risk transfer transactions—could create a new risk because these loans are more likely to default than rate/term refinancings and purchase loans. “However, whether cash-out refinancings will boost risks in individual RMBS deals depends on the loans’ other characteristics,” McNally added.