Note rate modifications and subprime default rates

Abstract

An important instrument to mitigate credit losses is modification of note rates of distressed borrowers. From a logistic model of early default, this article inferred the note rate impact on loan default probabilities, while controlling for loan characteristics (credit quality) and borrower location.

Notes

¹To stem subprime foreclosures, on December 2007, US Treasury Secretary announced a selective 5-year freeze on the rates of subprime adjustable-rate mortgages (ARMs).

²This parsimonious specification contrasts with the use of spatial effects that would involve modelling over 3400 municipalities (counties).

³The ARM rate reset is the difference between the fully index rate and the origination rate:   Rate reset _j  = fully indexed rate _j  − origination rate where   fully indexed rate _j  = LIBOR rate _j  + margin _j As the rate resets, the default rate will rise.