the time of origination or by a contemporaneous
measure of the ratio) is closely related to both the
likelihood of default and the size of the loss in the
event of default.
A recent analysis of the performance of nearly
425,000 loans originated over the 1975–83 period
illustrates these relationships. The analysis found that
conventional mortgages with loan-to-value ratios at
origination in the range of 91 percent to 95 percent
default more than twice as frequently as loans with
loan-to-value ratios in the range of 81 percent to
90 percent and more than five times as often as loans
with loan-to-value ratios in the range of 71 percent to
80 percent (table 1). Loss severity (that is, loss to the
lender measured as a proportion of the original loan
balance) is about 40 percent higher for loans with
original loan-to-value ratios in the range of 91 per-
cent to 95 percent than it is with loans with loan-to-
value ratios in the range of 81 percent to 90 percent.
6
Additional evidence regarding the relationship
between loan-to-value ratios at time of origination
and mortgage default is provided in an analysis con-
ducted by Duff & Phelps Credit Rating Company.
They found that among thirty-year fixed rate mort-
gages, those with a 90 percent loan-to-value ratio are
230 percent more likely to default than loans with an
80 percent loan-to-value ratio and that loans with a
95 percent loan-to-value ratio are 350 percent more
likely to default than a loan with an 80 percent
loan-to-value ratio.
7
Research also finds that the likelihood of default is
positively related to loan-to-value ratios among
single-family loans insured by the Federal Housing
Administration (FHA). The default rate among FHA-
insured loans with down payments of 3 percent or
less is approximately twice as high as the rate among
those with down payments of 10 percent to 15 per-
cent, and five times as high as the rate among loans
with down payments of 25 percent or more.
8
While research suggests that negative equity is a
necessary condition for default, it also suggests that
negative equity is not a sufficient condition (most
loans with negative equity do not default).
9
In line
with the triggering-event explanations, measures of a
borrower’s ability to pay also explain default and
delinquency, although delinquency relationships are
less well documented. Default rates have been found
to decrease generally with increases in levels of
wealth and liquid assets. Further, default likelihoods
are closely linked to measures of income stability.
Default rates are generally higher for the self-
employed and for those with higher percentages of
nonsalary income and lower for those with longer
employment tenures. Perhaps surprisingly, after con-
trolling for other factors, the initial ratio of debt
payment to income has been found to be, at best, only
weakly related to the likelihood of default.
10
Although a borrower’s credit history may play an
important role in determining mortgage loan perform-
ance, few published studies have been able to incor-
porate such information in their analyses. Relevant
credit history data are often difficult to obtain and
hard to quantify. The available evidence, however,
indicates that loans made to borrowers with flawed
credit histories (those who have had difficulties meet-
ing scheduled payments on past loans) default or
6. See Robert Van Order and Peter Zorn, ‘‘Income, Location, and
Default: Some Implications for Community Lending,’’ paper pre-
sented at the Conference on Housing and Economics, Ohio State
University, Columbus, July 1995. Further, a number of studies have
found that neighborhood and property conditions, which ultimately
affect property values and thus equity, are significant factors for
mortgage performance. See, for example, James R. Barth, Joseph J.
Cordes, and Anthony M.J. Yezer, ‘‘Financial Institution Regulations,
Redlining, and Mortgage Markets,’’ in The Regulation of Financial
Institutions, Conference Series 21, Federal Reserve Bank of Boston
(April 1980), pp. 101–43.
7. ‘‘The State of the Private Mortgage Insurance Industry,’’ Special
Report, Duff & Phelps Credit Rating Company, December 1995.
8. See ‘‘An Actuarial Review of the Federal Housing Administra-
tion’s Mutual Mortgage Insurance Fund,’’ prepared by Price
Waterhouse for the U.S. Department of Housing and Urban Develop-
ment, June 6, 1990, p. 12.
9. See Robert Van Order and Ann B. Schnare, ‘‘Finding Common
Ground,’’ Secondary Mortgage Markets, vol. 11 (Winter 1994),
pp. 15–19.
10. See Quercia and Stegman, ‘‘Residential Mortgage Default’’;
and James A. Berkovec, Glenn B. Canner, Stuart A. Gabriel, and
Timothy H. Hannan, ‘‘Race, Redlining, and Residential Mortgage
Loan Performance,’’ Journal of Real Estate Finance and Economics,
vol. 9 (November 1993), pp. 263–94; and Van Order and Zorn,
‘‘Income, Location, and Default.’’
1. Proportion of selected mortgages that defaulted
by year-end 1992 and resulting severity of loss,
by selected loan-to-value ratio ranges
Percent
Performance measure
Loan-to-value ratio (percent)
All
10–70 71–80 81–90 91–95
Proportion defaulted .. . .24 1.11 2.74 6.20 2.16
Average loss severity . . 22.3 29.2 34.4 47.9 39.2
Note. Mortgages were originated during the 1975–83 period and purchased
by Freddie Mac. Defaulted loans are those on which Freddie Mac acquired the
property through foreclosure. Loan-to-value ratio is the original loan amount
divided by the value of the property at origination. Loss severity is the total loss
before mortgage insurance payouts (if any) resulting from foreclosure (including
interest and transaction costs) divided by the mortgage balance.
Source. Robert Van Order and Peter Zorn, ‘‘Income, Location and Default:
Some Implications for Community Lending,’’ paper presented at the Conference
on Housing and Economics, Ohio State University, Columbus, July 1995.
624 Federal Reserve Bulletin July 1996