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Finance and Economics Discussion Series
Divisions of Research & Statistics and Monetary Affairs
Federal Reserve Board, Washington, D.C.

The Rise in Mortgage Defaults

Christopher J. Mayer, Karen M. Pence, and Shane M. Sherlund
2008-59

NOTE: Staff working papers in the Finance and Economics Discussion Series (FEDS) are preliminary
materials circulated to stimulate discussion and critical comment. The analysis and conclusions set forth
are those of the authors and do not indicate concurrence by other members of the research staff or the
Board of Governors. References in publications to the Finance and Economics Discussion Series (other than
acknowledgement) should be cleared with the author(s) to protect the tentative character of these papers.

The Rise in Mortgage Defaults
Chris Mayer, Karen Pence, and Shane M. Sherlund
November 2008

Christopher J. Mayer is Paul Milstein Professor of Finance and Economics, Columbia Business
School, New York, New York. He is also a Research Associate, National Bureau of Economic
Research, Cambridge, Massachusetts. Karen Pence and Shane M. Sherlund are Senior
Economists at the Household and Real Estate Finance Section, Federal Reserve Board,
Washington, D.C. Their e-mail addresses are <cm310@columbia.edu>,
<Karen.Pence@frb.gov>, and <Shane.M.Sherlund@frb.gov>, respectively.
We thank Erik Hembre, Amy Cunningham, Alex Chinco, and Rembrandt Koning for excellent
research assistance and especially Andreas Lehnert and Tomek Piskorski for helpful comments.
The views and conclusions expressed herein do not necessarily reflect the views of the Board of
Governors of the Federal Reserve System, its members, or its staff.

The mortgage market began suffering serious problems in mid-2005. According to data
from the Mortgage Bankers Association, the share of mortgage loans that were “seriously
delinquent” (90 days or more past due or in the process of foreclosure) averaged 1.7 percent
from 1979 to 2006, with a low of about 0.7 percent (in 1979) and a high of about 2.4 percent (in
2002). But by the second quarter of 2008, the share of seriously delinquent mortgages had surged
to 4.5 percent. These delinquencies foreshadowed a sharp rise in foreclosures: roughly 1.2
million foreclosures were started in the first half of 2008, an increase of 79 percent from the
650,000 in the first half of 2007 (Federal Reserve estimates based on data from the Mortgage
Bankers Association). No precise national data exist on what share of foreclosures that start are
actually completed, but anecdotal evidence suggests that historically the proportion has been
somewhat less than half (Cordell, Dynan, Lehnert, Liang, Mauskopf, 2008).
Mortgage defaults and delinquencies are particularly concentrated among borrowers
whose mortgages are classified as “subprime” or “near-prime.” Some key players in the
mortgage market typically group these two into a single category, which we will call “nonprime”
lending. Although the categories are not rigidly defined, subprime loans are generally targeted to
borrowers who have tarnished credit histories and little savings available for down payments.
Near-prime mortgages are made to borrowers with more minor credit quality issues or borrowers
who are unable or unwilling to provide full documentation of assets or income; some of these
borrowers are investing in real estate rather than occupying the properties they purchase. Nearprime mortgages are often bundled into securities marketed as “Alt-A.” Since our data are based
on the loans underlying such securities, we use the term “Alt-A” to refer to near-prime loans in
the remainder of this paper.
Subprime mortgages are not a new product, nor are complaints about subprime loans.
Since 1993, the Department of Housing and Urban Development (HUD) has been compiling a
list of lenders who specialize in subprime mortgage lending. About 700,000 mortgages were
originated annually between 1998 and 2000 by lenders whose primary business was originating
subprime loans (Mayer and Pence, forthcoming). A U.S. Department of Housing and Urban
Development report published in 2000 documented “the rapid growth of subprime lending
during the 1990s” and called for increased scrutiny of subprime lending due to “growing
evidence of widespread predatory practices in the subprime market.”

Despite these concerns, lending to risky borrowers grew rapidly in the 2000s, as shown in
Table 1. The number of subprime mortgages originated nearly doubled from 1.1 million in 2003
to 1.9 million in 2005. Near-prime Alt-A originations grew at an even faster rate, from 304,000
in 2003 to 1.1 million in 2005. In dollar terms, nonprime mortgages represented 32 percent of all
mortgage originations in 2005, more than triple their 10 percent share only two years earlier
(Inside Mortgage Finance, 2008). This momentum began to change in the middle of 2005, when
mortgage rates started to rise and house price appreciation first began to slow. Nonprime lending
leveled off in 2006, dropped dramatically in the first half of 2007, and became virtually
nonexistent through most of 2008.
The fall in nonprime originations coincided with a sharp rise in delinquency rates. The
share of subprime mortgages that were seriously delinquent increased from about 5.6 percent in
mid-2005 to over 21 percent in July 2008. Alt-A mortgages saw an even greater proportional
increase from a low of 0.6 to over 9 percent over the same time period. This dramatic rise in
delinquency rates has spurred widespread concerns about the effects on borrowers, lenders,
investors, local communities, and the overall economy.
This paper begins by looking at the various attributes of subprime and near-prime
mortgages: what types of loans were used; how they compare on standard measures of risk such
as loan-to-value ratios and credit scores; and whether the loans were originated to purchase
homes or to refinance existing mortgages. We then examine what shares of these loans were
relatively novel and complicated products: for example, some had interest rates that adjusted in
potentially confusing ways; did not require full documentation of income and assets; allowed
borrowers to postpone paying off mortgage principal; or imposed fees if borrowers prepaid their
mortgages within a certain period of time. The patterns of mortgage delinquency varied across
these characteristics, sometimes in unexpected ways.
We next investigate why delinquencies and defaults increased so substantially. We first
consider the proliferation of the novel products mentioned above. We find little evidence that the
rise in delinquencies through mid-2008 was linked to these products, although they may cause
problems in the future. We then consider incentives in the mortgage market, which during the
2000s shifted to an “originate-to-distribute” model, under which mortgage brokers originated
loans and then sold them to institutions that securitized them. As brokers did not bear the
ultimate costs of default, they may have had a lower incentive to screen applicants carefully

(Keys, Mukherjee, Seru, and Vig, 2008). We find that underwriting deteriorated along several
dimensions: more loans were originated to borrowers with very small down payments and little
or no documentation of their income or assets, in particular. The final culprit we consider is
changes in underlying macroeconomic conditions such as interest rates, unemployment, and
house prices. We find substantial evidence that declines in house prices are a key factor in the
current problems facing the mortgage market.

Attributes of Subprime and Alt-A Mortgages

Measuring the extent and characteristics of risky lending is not easy, due both to the lack
of a clear definition of “risky” loans and to limitations in the data collected. For many years,
researchers defined risky loans as those loans reported under the Home Mortgage Disclosure Act
(HMDA) that were originated by lenders on the HUD list of subprime lenders, using the
assumptions that all loans from these lenders were risky and no loans from other lenders were
risky. Avery, Brevoort, and Canner (2007) provide an overview of the HMDA data, which
contain only basic information on the loan and the borrower, including the income and race of
the borrower and the geographic location of the property collateralizing the mortgage.
As subprime lending grew, so too did the extent to which these loans were pooled into
securities and sold to investors. This process, known as securitization, transforms illiquid
individual mortgages into financial products that can be bought and sold as widely as stocks and
bonds. With securitization came improved data on these mortgages, so investors could monitor
the performance of their securities. One such data vendor is LoanPerformance, a subsidiary of
First American CoreLogic, Inc., which compiles detailed loan-level data on mortgages
securitized in subprime or Alt-A pools. These data appear to cover 90 percent or more of
securitized subprime mortgage originations (Mayer and Pence, forthcoming).
We use data licensed from LoanPerformance as the basis for our analysis. We define a
subprime loan as a loan in a subprime pool and likewise an Alt-A loan as a loan in an Alt-A
pool. Thus, these data will not include risky mortgages that lenders keep rather than securitize;
about 75 percent of subprime originations were securitized in recent years (Mayer and Pence,
forthcoming). We focus on 30-year mortgages originated on properties in the continental United
States between January 1, 2003, and June 30, 2007. We keep only mortgages for which the

lender has the first claim on the property if the borrower defaults (“first-lien” mortgages) and
drop mortgages without valid state identifiers. Our additional sample restrictions are that the loan
must have an initial balance greater than $10,000 and that it must be backed by a one- to fourfamily nonmanufactured home. For the 2003 to 2007 period, these restrictions cumulatively
reduce our sample from 14.6 million loans to 9.7 million loans.
Because nonprime securitization ground to a halt in the second half of 2007, the
LoanPerformance data provide little information on loans originated after mid-2007. But the
timeframe is suitable for examining conditions around the time of peak nonprime lending
activity. The data also allow us to examine separately subprime and Alt-A originations. Although
both types of mortgage originations increased rapidly between 2003 and 2005, they differ
substantially in their terms and features and in the characteristics of the borrowers who took
them.

Structure of Nonprime Mortgages
The overwhelming majority—over 75 percent—of subprime mortgages that originated
over the 2003–2007 period were so-called “short-term hybrids,” shown in Panel A of Table 2. In
this type of mortgage, the interest rate is fixed for two or three years and then becomes an
adjustable rate tied to market interest rates. The initial fixed rate is often called a “teaser” rate,
because the interest rate was typically scheduled to rise two or more percentage points after the
initial period ended. These mortgages were sometimes marketed as “credit repair” mortgages:
borrowers could make on-time payments during the fixed-rate period, thereby improving their
credit scores, and then refinance into prime mortgages before the mortgage switched to an
adjustable rate. Colloquially, these mortgages were often referred to as “2/28s,” with the “2”
referring to the initial two years of fixed interest rates and the “28” referring to the following 28
years of adjustable interest rates. Most of the remaining 25 percent of mortgages in these pools
were fixed-rate.
In contrast, short-term hybrids were a much smaller share—about 10 percent—of
mortgage originations in Alt-A pools, while fixed-rate mortgages were a larger share—about 40
percent. The remainder of the mortgages were “floating rate,” with interest rates that vary from
the beginning of the loan with changes in market rates, and long-term hybrids, with interest rates
fixed for five, seven, or ten years before becoming adjustable-rate.

Measures of Risk for Nonprime Lending
Subprime pools are clearly more risky than Alt-A pools when measured by what the
industry considers the two primary risk characteristics: the combined loan-to-value ratio and the
FICO credit score.1 “Combined” loan-to-value ratios include both first and second mortgages;
second mortgages are often referred to as “piggybacks.” The data will miss some “silent
seconds,” in which the borrower takes a second lien without notifying the original lender.
Anecdotal evidence suggests that such loans may have become more prevalent over this period.
As shown in Panel B of Table 2, the median combined loan-to-value ratio for subprime
purchase loans rose from 90 percent in 2003 to 100 percent in 2005, implying that in the final
years of the mortgage boom more than half of borrowers with subprime mortgages put no money
down when purchasing their homes. The combined loan-to-value ratios of subprime refinances
remained around 80 percent over this period, although these estimates may have become
artificially low over time if house price appraisals were biased upwards. Combined loan-to-value
ratios for Alt-A loans, although lower than those on subprime loans, also trended upward over
this period.
As shown in Panel C, purchase loans (as opposed to refinance loans) rose from 30 to 42
percent as a share of subprime originations over the 2003–2006 period, but were roughly
constant as a share of Alt-A originations. Piggyback loans became a more prominent component
of the combined loan-to-value ratio; the share of subprime originations with a piggyback rose
from 7 to 28 percent from 2003 to 2006, whereas the Alt-A share with a piggyback rose from 12
to 42 percent.
Subprime mortgage originations had much lower credit scores than Alt-A mortgage
originations (Panel C, Table 2). The median FICO score in subprime pools was around 615,
while the median FICO score in Alt-A pools was around 705. This risk characteristic, unlike
combined loan-to-values, remained flat over time.
On other observable risk dimensions, Alt-A mortgage pools appear riskier than subprime
pools. For example, investors are considered more likely to default on mortgages than owneroccupants, and about 25 percent of Alt-A mortgages were originated on investment properties,
1

A variety of credit scores are used in financial markets, but the most common credit score in mortgage markets is
the FICO score, developed by the Fair Isaac Corporation. The median FICO score is around 720 (Board of
Governors of the Federal Reserve System, 2007).

compared with about 10 percent of subprime mortgages.2 In addition, around 70 percent of loans
in Alt-A pools did not include full documentation of income, assets, or both (so-called low- or
no-documentation loans), compared with 35 percent of loans in subprime pools.
Mortgages in both types of pools often had features rarely seen in mortgages originated to
borrowers with better credit quality. In 2006 and 2007, monthly payments for about 25 percent
of subprime mortgages were calculated under the assumption that the borrowers would repay the
loans over a 40- or 50-year period. However, the mortgages had an actual life of 30 years, with
the remaining balance due as a lump sum at the end of the 30 years. We refer to these mortgages
as having “amortization greater than 30 years”; these products were unknown in subprime pools
before 2006. As houses became more expensive, subprime borrowers may have turned to these
products in an attempt to obtain more affordable monthly payments.
For Alt-A loans, instead of changing the assumed period of time over which borrowers
repay the balance, lenders often dropped the requirement that borrowers pay off any principal at
all in the early years of the mortgage. Forty percent of Alt-A mortgages involved only interest
payments without any scheduled principal repayment (only about 10 percent of subprime
mortgages have such an interest-only feature). Even more strikingly, another 20 percent of Alt-A
mortgages allowed the mortgage balance to increase over time (so-called “negative
amortization”); these mortgages are not found in subprime pools.
About 70 percent of subprime mortgages required borrowers to pay a fee if they
refinanced their mortgages before a certain period of time elapsed (a prepayment penalty),
compared with 40 percent of Alt-A mortgages. Prepayment penalties are controversial because
they might make it expensive to refinance, and many borrowers appear not to realize that their
mortgages include this provision. However, mortgage rates tend to be lower on loans with
prepayment penalties, resulting in more affordable monthly payments for borrowers (Mayer,
Piskorski, and Tchistyi, 2008).
In Table 2, Panel D, we see that interest rates at the time of origination on mortgages in
subprime pools were higher than those in Alt-A pools; these higher rates are not surprising given
the worse credit quality of subprime mortgages. Subprime fixed-rate mortgages, for example,
had an average mortgage rate at origination of 7.7 percent, a full percentage point higher than the

The data on investor ownership may be biased downward, as some investors may have reported that they were
planning on using a property as a primary residence, only to rent that property soon after purchase.

average 6.7 percent rate on Alt-A fixed-rate mortgages. Adjustable-rate mortgages showed a
similar pattern. Initial mortgage rates on Alt-A floating-rate mortgages hovered around an
extraordinarily low 2 percent—this rate represents a four percentage point discount relative to
the initial rate that the borrower would have had to pay for a mortgage without a teaser—whereas
initial rates on subprime short-term hybrids were around 8 percent, or about two to three
percentage points below the rate that the borrower would have had to pay for a mortgage without
a teaser. The rate spread between subprime and Alt-A increased over 2006 and 2007 as subprime
credit quality diminished (see also Demyanyk and Van Hemert, 2008).

Delinquency Rates by Types of Nonprime Loans
Within subprime and Alt-A mortgages, delinquencies have been particularly pronounced
for loans that include an adjustable interest rate component—floating-rate mortgages, short-term
hybrids, and long-term hybrids. For example, looking at subprime mortgages, the serious
delinquency rates for both adjustable-rate and fixed-rate loans were about 5.6 percent in mid2005. But by July 2008, serious delinquencies on adjustable-rate mortgages had risen to over 29
percent, while the similar rate for fixed-rate mortgages rose to 9 percent. Similarly, serious
delinquency rates for both adjustable-rate and fixed-rate Alt-A mortgages were about 0.6 percent
in mid-2005. But by July 2008, the delinquency rate on adjustable-rate Alt-A mortgages had
risen past 13 percent, while the delinquency rate on fixed-rate mortgages had risen over 5
percent.
Table 3 reports loan attributes for the four major mortgage products in subprime and AltA pools. The exceptionally high default rates of subprime adjustable-rate mortgages may be due
in part to the relatively poor risk attributes of these loans. Short-term hybrids, which make up
almost all subprime adjustable-rate mortgages, had an average FICO credit score of only 612 and
a mean combined loan-to-value ratio of 89 percent. By contrast, subprime fixed-rate mortgages
have higher credit scores (FICO of 627) and lower combined loan-to-value ratios (80 percent).
The higher default rates of Alt-A adjustable-rate mortgages, however, cannot be linked as
cleanly to worse risk attributes. Only the short-term hybrids in Alt-A pools have uniformly worse
risk attributes than fixed-rate mortgages, and short-term hybrids represent only 12 percent of all
Alt-A mortgages.

Mortgages originated to purchase properties have higher delinquency rates than
mortgages originated for refinancing, and the difference between the delinquency rates on these
products has soared over the last two years. Serious delinquency rates for both types of subprime
mortgages were around 5 percent in mid-2005, but by July 2008 rose to over 28 percent for
purchase mortgages and over 18 percent for refinancings. Serious delinquency rates for Alt-A
mortgages were below 1 percent in mid-2005, but rose to 11 percent for purchase mortgages and
over 8 percent for refinancings. These differences in delinquency rates cannot be cleanly
attributed to differences in risk attributes between the two groups, as shown in Table 4. FICO
credit scores are 19–35 points lower for refinancings, but combined loan-to-value ratios are also
lower. A higher percentage of purchase loans than refinance loans are on investor property, but
purchase loans are also much less likely to allow negative amortization.
The fact that default rates are higher on subprime purchase loans is somewhat surprising,
because refinance loans are generally considered to entail more risk. Borrowers who refinance
into subprime rather than prime loans, almost by definition, have not seen their financial
circumstances improve since they originated their mortgages. Borrowers may refinance into
subprime mortgages because financial circumstances force them to extract cash from their
properties. In fact, almost 90 percent of subprime refinancings involved some amount of cash
back (although this cash back could be the loan closing costs). Borrowers may also refinance into
subprime mortgages because they could not afford the payments on their initial mortgages. In
addition, fraud and underwriting problems may be harder to detect for refinancings, because
house values are based on appraisals rather than sales values.
Perhaps the explanation is that borrowers who refinanced were those who had already
shown some ability to repay their mortgages, whereas new homebuyers were untested.
Borrowers who refinance may also have lived in their houses longer, possibly becoming more
attached to their neighborhoods and benefiting from recent house price appreciation.
Alternatively, some borrowers who purchase a house with a subprime mortgage may be
speculating on house price appreciation and thus more likely to default when house prices are no
longer rising.

Mortgage Products and Features

One possible explanation for the rise in mortgage defaults is that borrowers did not
understand fully the complex products that became common in the nonprime mortgage market.
For example, borrowers with short-term hybrids might not have understood that their payments
could increase at the end of the initial fixed-rate period. Borrowers who were unprepared for this
increase might be unable to make their payments and thus might default on their mortgages.
However, as we show below, the complexity of these products does not appear to be the primary
culprit for the skyrocketing delinquency and foreclosure rates. And as of mid-2008, these
products were no longer offered in the mortgage market, in part because of the high lender losses
and in part because of regulatory changes that discouraged or prohibited some of these
provisions (Office of the Comptroller of the Currency, 2007, Board of Governors of the Federal
Reserve System, 2008).
We begin by examining three mortgage types that might be responsible for at least part of
the delinquency rise: mortgages with initial “teaser” rates that change to possibly higher
adjustable rates after two or three years; prepayment penalty clauses that establish large fees for
borrowers who pay off their mortgages early; and mortgages that allow for little or no
prepayment of principal, or even allow borrowers to make payments so low that their mortgage
principal grows over time. None of these provisions were new in the 2000s, but they were
common in the adjustable-rate mortgages that experienced the highest default rates, and their use
appears to have increased rapidly with the boom in nonprime mortgage lending.

Mortgage Rate Resets and Teasers
As the number of subprime loans nearly doubled from 2003 to 2005, the share of these
loans that were short-term hybrids grew as well to roughly 80 percent of all subprime loans
originated in 2005—or more than 1.5 million mortgages with teaser rates that would expire in
2007 and 2008. (Short-term hybrids are a much smaller share of Alt-A mortgages.) As noted in
the previous section, these mortgages have performed quite poorly, with serious delinquency
rates approaching 30 percent by mid-2008. These facts suggest that consumer problems with
teaser rates might be a significant contributor to the problems in the mortgage market.

Teaser-rate mortgages are controversial because of two fears: these loans may be targeted
to financially unsophisticated consumers who may not understand how teaser rates work and
thus may overestimate their ability to pay the higher rates; and originators may not have
adequately disclosed to consumers that they could face potentially large increases in rates at the
end of the teaser period. Borrowers with adjustable-rate mortgages appear to underestimate the
extent to which their interest rates could increase (Bucks and Pence, 2008). In addition,
borrowers tend to focus disproportionately on the initial rather than the long-term costs of loans
(Miles, 2003). Borrowers may discount the long-term costs of loans because they are optimistic
about their future prospects and put more weight on current than future happiness (Brunnermeier
and Parker, 2005; Laibson, 1997; Grubb, 2008). Lenders may also have little incentive to point
out these errors because lenders who educate naïve borrowers could forfeit profits (Gabaix and
Laibson, 2006; Campbell, 2006).
Industry participants claim that teaser mortgages were never designed as long-term
mortgage products. Instead, they argue that the two- or three-year teaser period was designed for
consumers with tarnished credit to improve their credit scores by making regular payments—and
then to refinance into more stable mortgages. A mortgage with a low initial interest rate can be
optimal for liquidity-constrained borrowers if borrowers understand the terms (Piskorski and
Tchistyi, 2007).
Moreover, the teaser rate for subprime mortgages was not especially low: throughout the
2003–2007 period, the initial teaser rate for short-term hybrids hovered in the range of 7.5 to 8.5
percentage points. But the rate to which the later adjustment would occur varied substantially.
When short-term interest rates were low in 2003 and early 2004, the fully indexed rate was lower
than the initial rate. In 2005, the fully indexed rate rose to nearly 3.5 percentage points above the
average teaser rate, so mortgages originated in that year faced a large potential rate shock at
expiration. The difference between the average teaser rate and the fully indexed rate fell a bit in
2006 and early 2007 to closer to 3 percentage points.
However, the distinguishing feature of the short-term hybrid mortgage—the change in the
mortgage rate two or three years after origination—does not seem to be strongly associated with
increased defaults, as least prior to early 2008. Sherlund (2008) and Gerardi, Shapiro, and Willen
(2007) show that, until recently, borrowers with hybrid mortgages appeared more likely to
refinance and prepay their mortgages around the first reset date but were not necessarily more

likely to default around that time. Instead, most of the defaults on short-term hybrids occurred
well before the end of the teaser period. Mortgage rate resets may yet cause difficulties going
forward: households trying to refinance hybrid short-term mortgages in 2008 and later face an
environment of stagnant to falling house prices and tightened underwriting standards. These
changes make refinancing more difficult and thus increase the chances of default (Sherlund,
2008). On the other hand, if short-term interest rates remain low, the payment shocks associated
with rate resets could be small.

Prepayment Penalties
Prepayment penalties are another mortgage feature commonly assumed to affect default
rates; for example, prepayment penalties were prevalent among the short-term hybrids that
experienced the highest default rates. In the Alt-A category, many floating-rate mortgages also
had prepayment penalties, although default rates were not nearly as high. Prepayment penalties
can be fairly large, typically running to six months of interest, or several thousand dollars (Board
of Governors, 2008, p. 44552). Many borrowers with prepayment penalties may not understand
that their contracts contain these penalties (Lacko and Pappalardo, 2007). Prepayment penalties
may also make it more difficult for borrowers who face unexpected financial difficulties to
obtain funds by selling their homes or refinancing their mortgages, and may leave borrowers
unable to lower their payments if interest rates fall or their credit profiles improve.
In the case of short-term hybrids, a particular concern is that prepayment penalties may
still be in effect when the interest rates switch from fixed- to variable-rate. At the end of the
teaser period, borrowers may be unable to afford their new payments, but may also be unable to
lower their monthly payments through refinancing because of prepayment penalties. However,
Table 2 (last row) suggests that this situation is uncommon: prepayment penalties were
scheduled to be in effect after the end of the teaser period for only 7 percent of the subprime
short-term hybrids originated from 2003 to 2007, and over these years the share originated with
such a provision dropped from 10 to 2 percent. For Alt-A pools, more than one-quarter had
prepayment penalties that extended beyond the teaser period, with the proportion over 30 percent
in the boom years of 2005 and 2006. But most of these mortgages were floating-rate mortgages,
whose interest rates adjust from the beginning of the mortgage as frequently as monthly. Almost

by definition, any prepayment penalty on a floating-rate mortgage will extend beyond the teaser
period.
Moreover, prepayment penalties can be welfare-improving. Because prepayment
penalties discourage borrowers from refinancing, cash flows from mortgages with these penalties
are more stable. These mortgages are more valuable to investors, and some of these savings may
be passed on to borrowers. In effect, risky borrowers get an interest rate discount to forgo the
option to refinance their mortgages if they get a good credit shock (known in the insurance
literature as “reclassification risk”). Mayer, Piskorski, and Tchistyi (2008) find that
reclassification risk is real for lenders: that is, risky borrowers who receive positive credit shocks
are more likely to prepay their mortgages than safer borrowers. They also find that subprime
borrowers with FICO scores below 620 receive the largest interest rate benefits from accepting a
prepayment penalty. (Other studies, such as Ernst, 2005, find a weaker or no relationship
between interest rates and prepayment penalties.) In addition, Mayer, Piskorski, and Tchistyi.
find that mortgages with prepayment penalties are less likely to default than comparable
mortgages without prepayment penalties, perhaps because the lower monthly payments make the
mortgages more affordable. Sherlund (2008) also finds no evidence that the probability of default
is higher when a prepayment penalty is in effect, although the probability of prepayment is
lower.
In short, prepayment penalties clearly decrease the probability that borrowers prepay
mortgages. Some borrowers may not know that their mortgages include these provisions, and
borrowers who need to refinance to access cash in an emergency will find this access more costly
if prepayment penalties are in effect. However, the bulk of the evidence suggests that these
penalties did not contribute to the rise in defaults through mid-2008.

Negative Amortization, Interest-Only, and 40-Year Amortization Features
Over the 2003–2007 period, originators of nonprime mortgages increasingly designed
and promoted products with lower monthly mortgage payments. By 2006 and 2007, more than
one-third of subprime 30-year mortgages had amortization schedules longer than 30 years, more
than 44 percent of Alt-A loans allowed borrowers to pay only the interest due on their
mortgages, and more than one-quarter of Alt-A loans gave borrowers the option to pay less than
the interest due and thus grow their mortgage balances (so-called “option adjustable-rate

mortgages”). Because borrowers pay down principal more slowly, if at all, with these mortgages,
loan-to-value ratios remain elevated and borrowers have a higher incentive to default.
As with prepayment penalties, theory suggests that credit-constrained borrowers can
benefit from these mortgage provisions. Piskorski and Tchistyi (2007) present a model
suggesting that these products increase affordability by alleviating liquidity constraints.
However, the groups most likely to face liquidity constraints may also be those most likely to
have difficulty understanding these provisions (Bucks and Pence, 2008).
The vast majority of borrowers with option adjustable-rate mortgages appear to have
exercised the option to make small “minimum” payments on their mortgages. By making
payments less than the accrued interest due, these borrowers increased, rather than decreased,
their mortgage balances over time. Figure 1 shows the share of borrowers with option adjustablerate mortgages in the 2004, 2005, 2006, and 2007 vintages whose mortgage balances in a given
number of months were larger than at origination. Most borrowers in the 2004 vintage paid off at
least the interest in the first months of their mortgages, but by month 18, over 50 percent of these
borrowers had balances that exceeded their size at origination.
The share making small payments increased even more dramatically and at earlier loan
ages for more recent vintages. For mortgages originated in 2007, 60 percent had larger balances
at month 4 than at origination, and over 90 percent had larger balances at month 8 than at
origination. On average, these mortgage balances were around $400,000 at origination;
borrowers who increased their balances increased them by around $1,250 a month. Although in
theory, borrowers could be using these products to smooth consumption by making lower
payments during periods when their incomes are below average or their expenses are above
average, the fact that the vast majority of borrowers are making only a minimum payment
suggests that other factors are at play.
These products generally only allow borrowers to make minimum or interest-only
payments for a period of time, usually five to ten years. At the end of this period, the payment
“recasts” into a payment large enough to pay off the mortgage balance in full by the end of the
mortgage. This recast can result in a substantial payment increase for at least three reasons: the
borrower now has to repay principal; that principal may have increased since the mortgage was
originated if the borrower only made minimum payments; and the borrower has to pay off the
principal over a shorter period of time than the original 30 years.

Serious delinquency rates on option adjustable-rate mortgages have risen even more
steeply than on Alt-A mortgages overall, increasing from 1 percent in January 2007 to 15 percent
in July 2008. Recasts, however, cannot explain this rise as most of these mortgages are not
scheduled to recast until 2010 or later. However, recasts may become a problem in the future if
house prices do not recover and refinancing remains difficult. The fact that so many option
adjustable-rate mortgage borrowers exercised their option to make only minimum payments—
and thus increase their mortgage balances—suggests that the size of these future recasts will be
especially large.

Underwriting and Matching Loans to Borrowers

Deteriorating lending standards appear to be a larger culprit than product complexity in
the rise in defaults. Over time, lenders extended loans to increasingly risky borrowers. We find
that increases in observable factors such as loan-to-value ratios and in the share of loans with no
or low documentation contributed significantly to the rise in defaults, but other changes such as
the share of loans originated to investors or to borrowers with low credit scores appear to be less
important in the rise in defaults. Underwriting also appears to have deteriorated on aspects of the
loan that are less easy to measure, as evidenced by the increasing share of loans that defaulted
very soon after origination. Demyanyk and Van Hemert (2008), Keys, Mukherjee, Seru, and Vig
(2008), and Mian and Sufi (2008) also point to declining underwriting standards as a
contributing factor in the subprime crisis.

Early Payment Defaults
Historically, mortgages that are underwritten well are unlikely to default in the first year
of origination. Thus, the reports at the end of 2006 from lenders such as Ownit, New Century,
and Novastar that an unusually high share of their loans were becoming delinquent almost
immediately were a cause for alarm. This surge in early payment defaults is evident in our data.
On average, 1.5 percent of subprime loans in the 2000–2004 vintages were in default after 12

months, and the situation was just a bit worse for the 2005 vintage (Figure 2).3 However, 2
percent of outstanding loans in the 2007 vintage were in default within six months of origination,
and 8 percent were in default after 12 months.
Two possibilities might explain the dramatic rise in early payment defaults. First, many
borrowers may have been speculating on continued house price appreciation, and when that
appreciation did not materialize, those borrowers stopped making payments. Second, loans may
have been underwritten so poorly that borrowers were unable to afford the monthly payments
almost from the moment of origination.
As we show below, some of the deterioration in underwriting characteristics should have
been apparent to investors in mortgage-backed securities. However, the surge in early payment
defaults suggests that underwriting also deteriorated on dimensions that were less readily
apparent to investors. Research studies and anecdotal evidence suggest fraudulent practices by
both borrowers and mortgage brokers (for example, Morgenson and Creswell, 2007). Base Point
Analytics (2007) found some degree of borrower misrepresentations in as many as 70 percent of
early payment defaults in a study of three million loans originated between 1997 and 2006.
These practices may have been stoked by the rise of the “originate-to-distribute” model, which
has been faulted for not providing incentives for originators to provide proper due diligence on
loans.4

Combined Loan-to-Value Ratios and Second Liens
The rise in combined loan-to-value ratios suggests that lower down payments and an
increased use of second liens could have been important contributors to the mortgage crisis. As
noted earlier, the median combined loan-to-value ratio on subprime purchase originations rose
from 90 percent in 2003 to 100 percent for 2005 to 2007 originations, and the share of subprime
originations with a piggyback second lien at origination increased from 7 percent in 2003 to 28
percent in 2006. Similar increases in combined loan-to-value ratios for purchase originations and
3

Standard and Poor’s (2007) notes that lenders are often required by contract to repurchase loans that fail to make a
payment in the first three months after origination. As a result of this provision, our data from LoanPerformance
might under-report the actual incidence of very early payment defaults in all mortgages.
4
This statement is not quite true for early payment defaults; in this case, the originator may be required under
contract to re-purchase the loan from the mortgage pool. Of course, some originators ended up in bankruptcy while
facing a large number of unsatisfied repurchase claims. For this reason, thinly capitalized lenders still may lack
sufficient incentives to originate high-quality loans.

in the incidence of piggyback loans occurred for Alt-A originations. The increased share of
mortgages with piggybacks is also apparent in the HMDA data (Avery, Brevoort, and Canner,
2007).
The default rate patterns line up with the patterns in combined loan-to-value ratios.
Subprime purchase loans originated between 2005 and 2007 had both the highest default rates
and the highest combined loan-to-value ratios at origination; default rates were lower on two
groups with lower combined loan-to-value ratios: subprime purchase mortgages originated
before 2005, and Alt-A mortgages. Default rates and combined loan-to-value ratios were also
lower for refinances than purchases for both subprime and Alt-A originations, although
combined loan-to-value ratios for refinancings may have been held down by the rapid house
price appreciation over this period and by house value appraisals that were inflated to justify
larger mortgages. One piece of evidence that appraisals were manipulated for some refinanced
mortgages is that loans with combined loan-to-value of exactly 80 or 90 percent—which may
signify inflated appraisals—have higher default rates than loans with combined loan-to-value
slightly smaller or larger than these thresholds (Gerardi, Lehnert, Sherlund, and Willen,
forthcoming). However, the facts that defaults are higher for purchase mortgages and that
purchase originations rose as a share of subprime originations from 2003 to 2006 suggest that
inflated refinancing appraisals may not have been a major driver of the rise in mortgage default.
Sherlund (2008) documents, as have other researchers, that negative equity and a higher
combined loan-to-value ratio lead to more defaults, as these borrowers have a more difficult time
refinancing and have less to lose through default. Even controlling for combined loan-to-value
ratios, however, borrowers with piggyback second liens tend to default at higher rates: a
borrower with a 95 percent combined loan-to-value ratio first lien appears to be a better risk than
a borrower with an 85 percent first lien and a 10 percent second lien. It is not clear why the
composition of the combined loan-to-value matters so much for default. The commercial
mortgage market appears to realize that these piggyback liens pose additional risk, as
commercial mortgage contracts often have covenants that require borrowers to obtain the
lender’s permission before taking out additional debt. However, these covenants are uncommon
in the residential mortgage market.

Credit Scores
The fact that reported credit scores were stable from 2003 to 2007 suggests that
deterioration in credit scores was not a factor in the rise in defaults. As noted earlier, the median
FICO score in subprime pools was 615 in 2003 and 613 in 2007, while the median credit score in
Alt-A pools moved from 710 in 2003 to 707 in 2007. These statistics may mask a deterioration in
credit scores if borrowers artificially manipulated their scores through practices such as “renting
out” checking accounts or using the payment history from a stranger’s credit card. Some press
reports indicate that these practices seemed to “grow exponentially” in 2007 (Creswell, 2007).
By contrast, Keys, Mukherjee, Seru, and Vig (2008) argue that credit score manipulation is fairly
difficult and unlikely to be widespread. Manipulation of credit scores is hard to observe directly.
Our best evidence against credit score manipulation being a major factor in the rise in defaults is
indirect: Sherlund (2008) reports that credit scores continue to be an important factor in
predicting defaults for subprime loans, even for the most recent vintages where credit score
manipulation was reputedly more widespread.

No- and Low-Documentation Loans
The share of subprime mortgages with no or low documentation of income or assets rose
modestly from 32 percent of originations in 2003 to 38 percent in 2007. (We combine no- and
low-documentation loans because only a small number of loans are identified as “no-doc” in the
data.) The no- and low-doc share for Alt-A loans rose more steeply from 62 percent in 2004 to
81 percent in 2007. No- and low-doc loans were originally devised as a solution for borrowers,
such as self-employed workers, who have income that is variable or difficult to document.
However, over time these loans may have provided a mechanism for borrowers or lenders to
mask the fact that the borrowers might not have the resources to repay the loans.
No- and low-doc loans default at much higher rates than fully documented loans, and
prepay at lower rates (Sherlund, 2008). Over the 2005 to 2008 period, serious delinquencies on
no- and low-doc subprime mortgages rose from 5 to over 25 percent, compared with a rise from
5 to about 20 percent for fully documented loans. The fact that the no- and low-doc loans
comprised an increasing share of originations suggests that these loans contributed at least
somewhat to the rise in delinquencies overall.

Investor-owned Property
The share of subprime mortgages originated on investor-owned properties was constant
around 8 percent from 2003 to 2007, whereas the share of Alt-A originations made to investors
dipped from 27 to 21 percent. Investors tend to default at a higher rate than owner-occupiers
(Sherlund, 2008). In Massachusetts, multi-family dwellings—which are purchased at least
partially for investment reasons—accounted for more than one-third of recent foreclosures, even
though they represent only about 10 percent of owned homes.5 Over the 2005 to 2008 period,
delinquency rates rose from around 5 to over 22 percent for subprime mortgages on investorowned properties, compared with a rise from 5 to around 18 percent for owner-occupied
properties. However, because our data show that investors were a small or declining share of
overall originations, it seems unlikely that they account for much of the rise in the overall
delinquency rate unless they increasingly misrepresented themselves as owner-occupiers or their
unobserved characteristics deteriorated over time.

Interactions/Risk-Layering
Finally, the share of mortgages that were risky in more than one underwriting dimension
increased over this period. For instance, the share of subprime short-term hybrids originated with
low credit scores and high loan-to-value ratios increased from 7 percent in 2003 to 15 percent in
2006; the share with no- or low-documentation and high loan-to-value ratios increased by a
similar amount. These trends suggest that mortgage originators became increasingly confident in
their ability to underwrite risky mortgages as the mortgage boom progressed. However, these
types of interactions had never before been tested during economic downturns or periods of
stagnant to falling house prices.

Macroeconomic Factors

Increases in house prices, low interest rates, and low unemployment contributed to the
increased use (and extension) of subprime credit. Nationally, house price appreciation first began
to decelerate in 2005, and interest rates began increasing around the same time. By 2007, house

We thank Paul Willen for providing this statistic.

prices had declined in many areas of the country, and this deterioration, along with the increases
in unemployment in parts of the Midwest, appear to be large contributors to the mortgage crisis.

Interest Rates
Interest rates were historically low in 2003 and 2004, but began increasing after the
Federal Reserve started tightening monetary policy in mid-2004. The interest rates on most
subprime adjustable-rate mortgages were fixed for the initial two or three years of the loan and
then moved with changes in the six-month London Interbank Offered Rate (LIBOR). From June
2004 to June 2006, the six-month LIBOR rose from just under 2 percent to around 5.5 percent,
with an associated increase in the fully indexed rate from 8 to 11.5 percent. The one-year
Treasury bill rate, the equivalent index for many Alt-A adjustable-rate mortgages, rose by a
similar amount. These interest rate changes imply that a typical borrower with a subprime
adjustable-rate mortgage whose teaser period ended in mid-2006 could see a 25 percent increase
in monthly payments—around $250 on a $150,000 mortgage—at the time of the mortgage rate
reset.
However, borrowers could avoid this 25 percent increase by refinancing into another
short-term hybrid; under the subprime teaser rates in effect in mid-2006, their payments would
increase by only 10 to 15 percent. Because of house price increases over this period, most
borrowers had accumulated enough home equity to refinance fairly easily. But when house
prices stopped rising, mortgage defaults accelerated, and lenders tightened underwriting
standards, higher-risk borrowers found it much more difficult to refinance and some borrowers
may have been forced to default. The greater difficulty in refinancing, though, was offset
somewhat by the decline in short-term interest rates that followed Federal Reserve rate cuts in
2007 and 2008. A typical subprime short-term hybrid experiencing a rate reset in June 2008
would have an associated monthly payment increase of about 3 percent, or about $40 on a
$150,000 mortgage.

Unemployment
Ohio, Michigan, and Indiana were the first states to see large increases in delinquency
rates. The serious delinquency rate on subprime mortgages in these states was 14 percent at the
beginning of 2007, well above the 8.5 percent delinquency rate for the nation as a whole. The

heightened delinquencies in these states were preceded by difficult economic conditions,
including three to four years of elevated unemployment rates and at least one to two years of
stagnant to falling house prices.
In areas with widespread increases in unemployment, house prices generally decline;
demand for housing falls as income drops and workers migrate to other areas in search of jobs.
As a result, it can be difficult to establish whether defaults in these areas are due to
unemployment or house prices. In contrast, as we discuss below, borrowers who lose their jobs
in an area where house prices are rising are more likely to sell their houses than default on their
mortgages.

House Prices
House prices rose at an average annual rate of 11 percent from 2000 through 2005,
stagnated, and then fell at an average annual rate of 10 percent from mid-2006 to mid-2008, as
measured by the S&P/Case-Shiller national house price index. The increase in house prices
likely fueled the growth of the nonprime mortgage market. As house prices skyrocketed,
borrowers in search of affordable monthly payments may have turned to products with interestonly provisions, extended amortization, or other features more common in the nonprime market.
Borrowers may have been comfortable taking these risks because they believed house prices
would continue to rise. This belief in continued house price appreciation may have influenced
other borrowers to buy investment properties; Alt-A mortgages, in particular, were often used by
investors. Mayer and Pence (forthcoming) document that areas with high house price
appreciation saw a rise the following year in subprime mortgage originations. Further, Nadauld
and Sherlund (2008) show that mortgages from areas experiencing high house price appreciation
are easier to securitize.
Likewise, the decline in house prices had a disproportionate effect on the nonprime
mortgage market. Many nonprime borrowers put down small or no down payments when they
purchased their homes, and as a result were likely to have negative equity in their homes when
house prices fell. Because house prices in Ohio, Michigan, and Indiana began declining several
months before the rest of the country, the share of borrowers with negative equity was initially
highest in these states and reached one in three by mid-2008, as we see in Figure 3. In California,
Florida, Arizona, and Nevada, where house prices appreciated dramatically in 2004 and 2005

and subsequently dropped sharply, over half of subprime borrowers had negative equity in their
homes by mid-2008; elsewhere, about ten percent of subprime borrowers had negative equity by
that time.
Although borrowers with Alt-A mortgages tended to have a bit larger down payments
and thus more initial equity than borrowers with subprime mortgages, the negative equity picture
for Alt-A mortgages is surprisingly similar to the subprime picture. As of mid-2008, over half of
borrowers in California, Florida, Arizona, and Nevada, over a third of borrowers in Ohio,
Michigan, and Indiana, and over ten percent of borrowers in the rest of the United States had
negative equity. The only difference between the subprime and Alt-A pictures is the contour of
the line for California, Florida, Arizona, and Nevada, which began accelerating later for Alt-A
mortgages than for subprime mortgages but reached similar levels by the beginning of 2008. The
large share of mortgages with negative equity in California, Florida, Arizona, and Nevada is
particularly sobering because, as of July 2008, mortgages in these states accounted for 40 percent
of outstanding subprime mortgages nationwide (dollar-weighted) and over 55 percent of Alt-A
mortgages.
When borrowers with positive equity in their homes experience financial difficulties, they
are likely to respond by refinancing or selling their homes. Even if a borrower cannot afford the
current mortgage, it is more profitable for a borrower to sell the house than to have the bank sell
it through a foreclosure. Borrowers with negative equity, however, face no such incentive, and
are more likely to default on their loans (Foote, Gerardi, and Willen, 2008; Gerardi, Lehnert,
Sherlund, and Willen, forthcoming; Sherlund, 2008).
As noted earlier, California, Florida, Arizona, and Nevada experienced much higher
house price appreciation over the first few years of the 2000s than the rest of the nation.
Correspondingly, only about 3 percent of subprime mortgages originated in these states from
2000 to 2004 defaulted within 3 years of origination, compared with over 8 percent of subprime
mortgages originated in the nation overall.
As house prices began to decelerate in 2005, this pattern began to reverse. Over 17
percent of the subprime mortgages that originated in California, Florida, Arizona, and Nevada in
2005 defaulted by mid-2008, compared with nearly 14 percent nationwide. In 2006, house prices
began to drop more sharply than in these states. Around 26 percent of 2006 subprime mortgage
originations and 18 percent of 2007 subprime mortgage originations in California, Florida,

Arizona, and Nevada were in default as of mid-2008. For the nation as a whole, only 13 and 9
percent of subprime mortgages originated in these years were in default.
We assume throughout this paper that the causality largely runs from house prices to
nonprime lending. However, there were undoubtedly feedback effects from nonprime lending to
house prices as well. As underwriting standards loosened, more new borrowers entered the
market, thereby increasing the demand for housing (Mayer and Sinai, 2007, Mian and Sufi,
2008). The recent tightening of credit standards has likely kept borrowers out of the mortgage
market and decreased housing demand and, by extension, house prices. Going forward, the glut
of foreclosed properties may push house prices down even further.

Conclusions and Future Research

Slackened underwriting standards—manifested most dramatically by lenders allowing
borrowers to forego down payments entirely—combined with stagnant to falling house prices in
many parts of the country appear to be the most immediate contributors to the rise in mortgage
defaults. The surge in early payment defaults and the rise in the share of mortgages with low or
no documentation suggest that underwriting also deteriorated along other dimensions. Because
down payments were so small, when house prices declined, many borrowers had little or no
equity in their properties and thus less incentive to repay their mortgages. In the industrial
Midwest, economic distress was also a factor in the heightened defaults. Unorthodox mortgage
features such as rate resets, prepayment penalties, or negative amortization provisions do not
appear to be significant contributors to date to the defaults because borrowers who experienced
problems with these provisions could refinance into other mortgages. However, as markets
realized the extent of the poor underwriting and house prices began to fall, refinancing
opportunities became more limited. Borrowers may not be able to resolve their problems with
these products through refinancing going forward and thus may be forced to default. Our
conclusions are consistent with other studies (Sherlund, 2008; Gerardi, Lehnert, Sherlund, and
Willen, forthcoming; Gerardi, Shapiro, and Willen, 2007; Haughwout, Peach, and Tracy, 2008).
Our conclusions run counter to the popular perception that unorthodox mortgage features
are responsible for the surge in defaults. At first glance, the fact that the most common subprime
mortgage was a confusing and complicated product—a short-term hybrid with a prepayment

penalty—and that delinquency rates were highest on these products suggest that the mortgage
type itself must be to blame. We suggest instead that default rates were highest on these products
because they were originated to the borrowers with the lowest credit scores and highest loan-tovalue ratios. This interpretation raises the questions of why the riskiest borrowers were matched
with the most complicated products and whether it was borrowers, lenders, or both who
misjudged the likelihood that borrowers would default. Did borrowers seek out this product
because it offered the lowest initial payment and they were focused on short-term affordability?
Or did lenders offer this product to borrowers because they thought that this combination of
features allowed them to manage the risks of lending to borrowers with high probabilities of
default?
News accounts often suggested that borrowers were steered into subprime adjustable-rate
mortgages when they could have qualified for fixed-rate or prime mortgages (Brooks and Simon,
2007). Given the poor credit profiles of these borrowers and the high price of housing relative to
their incomes, however, it seems more likely that, in the absence of subprime adjustable-rate
mortgages, these borrowers would not have gotten credit at all. If so, several more questions
spring to mind: First, were these borrowers better off for having the opportunity of home
ownership when the possibility of failure was so high? Second, were the associated gains in the
homeownership rate illusory, or will some of these gains be sustained?6 Finally, to what extent
were house prices pushed up by the entrance of these new buyers into the market?
Alt-A mortgages pose a similar set of questions and issues. As with subprime mortgages,
the complicated provisions of these mortgages do not appear to be responsible for the sharp rise
in delinquencies. Very few of these mortgages are scheduled to “recast” before 2010, when their
payments could potentially increase dramatically. But even more than subprime mortgages, these
mortgages were originated to borrowers who may have been speculating on future house price
appreciation. As these borrowers were somewhat better credit risks than borrowers with
subprime mortgages, they tended to have lower combined loan-to-value ratios at origination and
better credit scores. However, the areas where investors speculated most heavily on house price
appreciation were also the areas that experienced the most severe house price declines. Although
6

The national homeownership rate rose from 65 percent at the end of 1995 to 69 percent at the end of 2005. This
data is from the Current Population Survey/Housing Vacancy Survey, Series H-111 Reports, Bureau of the Census,
Washington, D.C.

the initial equity cushion kept Alt-A mortgages from defaulting as quickly as subprime
mortgages, default rates on Alt-A loans, and on option adjustable-rate mortgages in particular,
began to skyrocket in 2007, about twelve months after the surge in subprime delinquencies.
Going forward, the key question is whether house prices will decline enough so that borrowers
with prime mortgages are also left with little or no equity and thus a higher chance of default.

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Figure 1
Option Adjustable-Rate Mortgages with Balances Larger than at Origination
Percent

Source: Calculations from First American LoanPerformance data.
Note: Figure 1 shows the percentage of borrowers with option adjustable-rate mortgages in the 2004,
2005, 2006, and 2007 vintages whose mortgage balances in a given number of months were larger than at
origination. The sample is restricted to thirty-year, first-lien mortgages originated on one- to four-family
properties in the contiguous United States.

Figure 2
Early Payment Defaults on Subprime Loans

Source: Calculations from First American LoanPerformance data.
Note: Figure 2 shows the percentage of borrowers with subprime mortgages in the 2004, 2005, 2006, and
2007 vintages whose mortgage balances in a given number of months were in default. Sample restricted
to thirty-year, first-lien mortgages originated on one- to four-family properties in the contiguous United
States. Adjustments have been made for calendar effects.

Figure 3
Percent of Nonprime Loans with Negative Equity
Panel A: Subprime Loans

Panel B: Alt-A Loans

Source: Calculations from S&P/Case-Shiller, Office of Federal Housing Enterprise Oversight, and First
American LoanPerformance data.
Note: Sample restricted to thirty-year, first-lien mortgages originated on one- to four-family properties in
the contiguous United States.

Table 1
Number of Subprime and Alt-A Mortgage Originations by Year
Collateral type
Subprime
Alt-A

2003

2004

2005

2006

2007
All
(Jan–June)
1,081,629 1,669,594 1,921,637 1,445,425 233,725 6,352,010
303,969 712,056 1,093,797 921,212
279,114 3,310,148

Source: Federal Reserve Board calculations based on data from First American LoanPerformance.
Note: Sample restricted to thirty-year, first-lien mortgages originated on one- to four-family properties in
the contiguous United States.

Table 2
Attributes for Mortgages in Subprime and Alt-A Pools
Panel A: Market Share of Loans by Year and Loan Type
Collateral type
Loan type
2003 2004 2005 2006

Subprime

Alt-A

Fixed rate
Floating rate
Short-term hybrid
Long-term hybrid
Fixed rate
Floating rate
Short-term hybrid
Long-term hybrid

30%
0%
68%
1%
69%
5%
11%
16%

21%
0%
77%
1%
36%
20%
23%
21%

17%
0%
81%
2%
39%
26%
12%
23%

20%
0%
77%
3%
39%
23%
6%
32%

2007
(Jan–June)
27%
0%
68%
4%
42%
12%
1%
45%

All
21%
0%
76%
2%
41%
21%
12%
26%

Panel B: Median Combined Loan-to-Values for Mortgages in Subprime and Alt-A Pools
Collateral type
Loan purpose
2003 2004 2005 2006
2007
All
(Jan-June)
Purchase
90
95
100 100
100
95
Subprime
refinance
80
80
80
80
80
80
Purchase
90
90
90
95
95
90
Alt-A
refinance
74
75
75
79
79
76

Panel C: Attributes of Mortgages in Subprime and Alt-A pools
Collateral type
2003 2004 2005 2006

2007
All
(Jan–June)
30 36 40 42
31
37
46 54 52 49
37
50
7
15 24 28
15
19
12 27 35 42
33
33
615 615 618 616
613
616
710 706 708 701
707
706
8
8
7
7
8
7
27 23 22 21
22
22
32 34 36 38
34
35
63 62 69 80
81
71
0
0
4
23
26
7
0
0
0
1
1
0
2
11 21 13
11
13

Subprime
Alt-A
Subprime
% piggyback loans
Alt-A
Subprime
Median FICO credit score
Alt-A
% originated on investor
Subprime
property
Alt-A
% with low or no
Subprime
documentation
Alt-A
Subprime
% with amortization > 30 years
Alt-A
% requiring interest payments Subprime
only (in early years of
Alt-A
mortgage)
% allowing negative
Subprime
amortization
Alt-A
Subprime
% with prepayment penalty
Alt-A
% with prepayment penalty
Subprime
extending beyond teaser period
(adjustable-rate mortgages only) Alt-A
% purchase loans

16
0
2
74
26

37
0
16
73
33

40
0
24
72
39

44
0
26
70
44

52
0
30
69
40

39
0
21
72
38

2007
(Jan-June)
8.75
8.09
8.56
7.99
6.96
2.33
6.79
5.93

All

Panel D: Average Initial Mortgage Rate by Year and Loan Type
Collateral type
Loan type
2003 2004 2005 2006

Subprime

Alt-A

Fixed rate
Floating rate
Short-term hybrid
Long-term hybrid
Fixed rate
Floating rate
Short-term hybrid
Long-term hybrid

7.51
6.79
7.76
6.43
6.51
3.72
6.00
5.60

7.24
6.50
7.33
6.32
6.46
2.06
5.77
5.63

7.45
6.60
7.57
6.80
6.44
1.66
6.50
6.20

8.40
8.36
8.53
7.74
7.18
2.00
7.31
6.78

7.67
7.22
7.79
7.08
6.69
1.92
6.26
6.23

Table 3
Attributes of Various Mortgage Types in Subprime and Alt-A pools, 2003–
2007

Collateral type
Median combined
loan-to-value ratio
Median FICO credit
score

Subprime
Alt-A
Subprime
Alt-A
Subprime
Median initial rate
Alt-A
% originated on
Subprime
investor property
Alt-A
% with prepayment Subprime
penalty
Alt-A
% with prepayment Subprime
penalty extending
beyond teaser period Alt-A
% allowing negative Subprime
amortization
Alt-A
% with low or no
Subprime
documentation
Alt-A
% with amortization Subprime
> 30 years
Alt-A

90
80
625
703
7.22
1.92
12
17
57
74
52

Longterm
hybrid
85
84.28
660
710
7.79
6.26
11
20
66
35
0

Shortterm
hybrid
89.47
90
612
694
7.08
6.23
7
21
72
48
6

72
3
91
45
80
8
0

0
0
8
40
73
11
1

3
0
0
37
68
9
1

Fixed
rate

Floating
rate

80
80
627
708
7.67
6.69
9
26
73
20
.
.
0
0
27
66
0
0

Table 4
Attributes of Purchase and Refinance Mortgages
Purchase
mortgage
95
90
637
715
7.75
5.98
10
25
74
34
0
13
41
69
9
0

Collateral type
Median combined loan-to- Subprime
value ratio
Alt-A
Subprime
Median FICO credit score
Alt-A
Subprime
Median initial rate
Alt-A
% originated on investor
Subprime
property
Alt-A
Subprime
% with prepayment penalty
Alt-A
% allowing negative
Subprime
amortization
Alt-A
% with low or no
Subprime
documentation
Alt-A
% with amortization > 30 Subprime
years
Alt-A

Refinance
mortage
80
76
602
696
7.75
5.08
6
19
71
42
0
29
32
73
7
0

Full text of The Rise in Mortgage Defaults

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