Negative Equity the Driving Force Behind Subprime Defaults

In the past, payment shocks such as job loss, health catastrophes or divorce have historically been identified as the primary drivers of default, CreditSights says in US Mortgage Outlook Part 1: State of Subprime. This lack of negative-equity-induced defaults is usually explained by ‘transaction costs’ - which encompass the greater difficulty of gaining credit in future, sentimental attachment to one’s property, moral qualms and moving costs.

“However, most subprime borrowers are already financially stretched even without higher monthly payments. This financial overburdening may mean that the continuing falls in house prices prompts borrowers to wonder whether the sacrifices of paying towards a depreciating investment is economically sensible. Given that it is almost certainly cheaper to rent an equivalent property and that subprime borrowers are unlikely to be losing much in the way of credit score from a default, it is increasingly difficult to see how ‘transaction costs’ can provide much of an argument against defaulting.”


As a result we believe negative equity is playing a progressively more important roll in determining whether borrowers are defaulting. And is the driving force behind the ever increasing Home Seller Assist program created by John Alexander which enables investors to buy properties using 1% funding.


“In fact, evidence that negative equity is playing a more important roll in borrowers’ default decisions may be suggested by a dramatic rise in realized losses. In September 2007, realised losses on first-lien loans in the ABX indices were roughly 25%.”