Credit Risk of Low Income Mortgages

Abstract

Using Fannie Mae loan-level data on fixed-rate owner occupied purchase mortgage acquisitions, we examine the role of tightened underwriting standards on the default risk of low and moderate income (LMI) homebuyers. In three distinct underwriting regimes and subsequent housing market environments – 2002-2004, 2005-2007 and 2011-2013 – we find that loan performance improves as a borrower’s income relative to area median income rises – for both actual performance and the marginal predicted performance after controlling for standard credit risk measures, vintage and region. Second, for pre-crisis loans applying the tighter underwriting standards of the post-crisis period dramatically reduces the performance differences across relative income, indicating the importance of underwriting standards for sustainable low and moderate income lending and home ownership. Finally, for all but very-low income borrowers (<= 50% area median income), credit risk is well accounted for by the usual risk factors considered in the underwriting process along with vintage and regional controls.