Did Prepayments Sustain the Subprime Market?

G. Bhardwaj, R. Sengupta

Research output: Working paperDiscussion paperOther research output

266 Downloads (Pure)

Abstract

This paper demonstrates that the reason for widespread default of mortgages in the subprime market was a sudden reversal in the house price appreciation of the early 2000's. Using loan-level data on subprime mortgages, we observe that the majority of subprime loans were hybrid adjustable rate mortgages, designed to impose substantial financial burden on reset to the fully indexed rate. In a regime of rising house prices, a financially distressed borrower could avoid default by prepaying the loan and our results indicate that subprime mortgages originated between 1998 and 2005 had extremely high prepayment rates. Most important, prepayment rates on subprime mortgages were extremely high (i) not just for ARMs but FRMs as well, (ii) even before the reset dates on hybrid-ARMs and (iii) despite prepayment penalties on the contract. However, a sudden reversal in house price appreciation increased default in this market because it made this prepayment exit option cost-prohibitive. In short, prepayments sustained the subprime boom and the extremely high default rates on 2006-2007 vintages were largely due to the inability of these mortgages to prepay (an option that was available for mortgages of earlier vintages).
Original languageEnglish
Place of PublicationTilburg
PublisherFinance
Number of pages45
Volume2009-38 S
Publication statusPublished - 2009

Publication series

NameCentER Discussion Paper
Volume2009-38 S

Fingerprint

Prepayment
Subprime
Loans
House prices
Subprime mortgages
Mortgages
Reversal
Burden
Penalty
Exit option
Adjustable rate mortgages
Default rate
Costs

Keywords

  • mortgages
  • subprime
  • refinance
  • prepayment
  • crisis

Cite this

Bhardwaj, G., & Sengupta, R. (2009). Did Prepayments Sustain the Subprime Market? (CentER Discussion Paper; Vol. 2009-38 S). Tilburg: Finance.
Bhardwaj, G. ; Sengupta, R. / Did Prepayments Sustain the Subprime Market?. Tilburg : Finance, 2009. (CentER Discussion Paper).
@techreport{d478005b3e294cf0b3059aaad09eee39,
title = "Did Prepayments Sustain the Subprime Market?",
abstract = "This paper demonstrates that the reason for widespread default of mortgages in the subprime market was a sudden reversal in the house price appreciation of the early 2000's. Using loan-level data on subprime mortgages, we observe that the majority of subprime loans were hybrid adjustable rate mortgages, designed to impose substantial financial burden on reset to the fully indexed rate. In a regime of rising house prices, a financially distressed borrower could avoid default by prepaying the loan and our results indicate that subprime mortgages originated between 1998 and 2005 had extremely high prepayment rates. Most important, prepayment rates on subprime mortgages were extremely high (i) not just for ARMs but FRMs as well, (ii) even before the reset dates on hybrid-ARMs and (iii) despite prepayment penalties on the contract. However, a sudden reversal in house price appreciation increased default in this market because it made this prepayment exit option cost-prohibitive. In short, prepayments sustained the subprime boom and the extremely high default rates on 2006-2007 vintages were largely due to the inability of these mortgages to prepay (an option that was available for mortgages of earlier vintages).",
keywords = "mortgages, subprime, refinance, prepayment, crisis",
author = "G. Bhardwaj and R. Sengupta",
note = "This is also EBC Discussion Paper 2009-09 S Pagination: 45",
year = "2009",
language = "English",
volume = "2009-38 S",
series = "CentER Discussion Paper",
publisher = "Finance",
type = "WorkingPaper",
institution = "Finance",

}

Bhardwaj, G & Sengupta, R 2009 'Did Prepayments Sustain the Subprime Market?' CentER Discussion Paper, vol. 2009-38 S, Finance, Tilburg.

Did Prepayments Sustain the Subprime Market? / Bhardwaj, G.; Sengupta, R.

Tilburg : Finance, 2009. (CentER Discussion Paper; Vol. 2009-38 S).

Research output: Working paperDiscussion paperOther research output

TY - UNPB

T1 - Did Prepayments Sustain the Subprime Market?

AU - Bhardwaj, G.

AU - Sengupta, R.

N1 - This is also EBC Discussion Paper 2009-09 S Pagination: 45

PY - 2009

Y1 - 2009

N2 - This paper demonstrates that the reason for widespread default of mortgages in the subprime market was a sudden reversal in the house price appreciation of the early 2000's. Using loan-level data on subprime mortgages, we observe that the majority of subprime loans were hybrid adjustable rate mortgages, designed to impose substantial financial burden on reset to the fully indexed rate. In a regime of rising house prices, a financially distressed borrower could avoid default by prepaying the loan and our results indicate that subprime mortgages originated between 1998 and 2005 had extremely high prepayment rates. Most important, prepayment rates on subprime mortgages were extremely high (i) not just for ARMs but FRMs as well, (ii) even before the reset dates on hybrid-ARMs and (iii) despite prepayment penalties on the contract. However, a sudden reversal in house price appreciation increased default in this market because it made this prepayment exit option cost-prohibitive. In short, prepayments sustained the subprime boom and the extremely high default rates on 2006-2007 vintages were largely due to the inability of these mortgages to prepay (an option that was available for mortgages of earlier vintages).

AB - This paper demonstrates that the reason for widespread default of mortgages in the subprime market was a sudden reversal in the house price appreciation of the early 2000's. Using loan-level data on subprime mortgages, we observe that the majority of subprime loans were hybrid adjustable rate mortgages, designed to impose substantial financial burden on reset to the fully indexed rate. In a regime of rising house prices, a financially distressed borrower could avoid default by prepaying the loan and our results indicate that subprime mortgages originated between 1998 and 2005 had extremely high prepayment rates. Most important, prepayment rates on subprime mortgages were extremely high (i) not just for ARMs but FRMs as well, (ii) even before the reset dates on hybrid-ARMs and (iii) despite prepayment penalties on the contract. However, a sudden reversal in house price appreciation increased default in this market because it made this prepayment exit option cost-prohibitive. In short, prepayments sustained the subprime boom and the extremely high default rates on 2006-2007 vintages were largely due to the inability of these mortgages to prepay (an option that was available for mortgages of earlier vintages).

KW - mortgages

KW - subprime

KW - refinance

KW - prepayment

KW - crisis

M3 - Discussion paper

VL - 2009-38 S

T3 - CentER Discussion Paper

BT - Did Prepayments Sustain the Subprime Market?

PB - Finance

CY - Tilburg

ER -

Bhardwaj G, Sengupta R. Did Prepayments Sustain the Subprime Market? Tilburg: Finance. 2009. (CentER Discussion Paper).