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Default Risk on Non-Conforming Loans Keeps Rising

The risk of default on newly originated, nonprime credit quality mortgage loans rose slightly this summer, according to a quarterly analysis done by University Financial Associates. The firm's Default Risk Index for the summer of 2003 rose to 103 from 102 the previous quarter. A reading of 100 reflects the average risk of default on nonprime loans originated during the 1990s.

"The index has been flat for over a year because falling interest rates, which reduce payment burdens for borrowers, are offsetting the eroding prospects for the underlying housing collateral," said Dennis Capozza, professor of finance at the University of Michigan and a principal in UFA.

Under current economic conditions, nonprime lenders should expect defaults on loans currently being originated to be significantly higher than the average of loans originated in 1998 and 1999, but only 3% higher than the average rate on mortgages originated in the 1990s overall, he said.

The UFA analysis is based on a constant quality loan, meaning it measures the default risk on a loan with the same borrower, loan and collateral characteristics. The index reflects only the changes in economic conditions, which have been less favorable in the last two years than in the prior two-year period.

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