Trend in first-mortgage defaults changed in August

The first-mortgage default rate in August was the same as its July number, ending an upward trend that had brought it within range of the market’s September 2020 high.

The default rate for first-lien home loans last month remained at 0.42%, according to an index published by Standard & Poor’s Dow Jones and Experian. That mirrored a trend also seen in the broader universe of consumer credit, where the composite rate matched the previous month’s reading of 0.57%. 

However, the composite consumer-credit and first-mortgage default rates remained higher than a year ago when they were 0.39% and 0.27%, respectively.

Also, when the composite index was broken down into major metropolitan areas, three out of the five tracked by S&P Dow Jones and Experian registered consecutive-month increases. Chicago’s default rate rose to 0.70% from 0.67%, Dallas’ rose to 0.69% from 0.62% and Miami’s rose to 1.16% from 1.13% while Los Angeles’ dropped to 0.45% from 0.52% and New York’s fell to 0.58% from 0.65%.

In addition, the rate of distress in second-lien home loans ticked up by one notch from the previous month, rising to 0.44% from 0.43%. A year ago, the second-lien default rate matched the one for first mortgages at 27%.

The performance of second liens has been less consistent than that seen in the first-mortgage market because it has different drivers. For example, home equity lines of credit in the former market are closely tied to the short-term rates that federal monetary policymakers hiked by 75 basis points on Wednesday.

Also, while the first-lien market includes some products tied to short-term rates, it tends to be dominated by long-term financing, which is less directly correlated with Fed moves. At last count in the Mortgage Bankers Association’s latest loan application report, shorter-term adjustable-rate mortgages constituted just 9.1% of the market.

Although second lien rates have been rising, some borrowers still prefer them as a way to obtain extra cash, given the alternative may be to refinance a first mortgage from the past couple years, when long-term fixed rates were extraordinarily low.

Some broad economic forecasts suggest that rising consumer costs and interest rate hikes will continue to put upward pressure on default rates going forward, with government-sponsored enterprise Fannie Mae predicting that a recession could occur next year. However, other prognosticators think the odds of a recession are less than 50%.