Journal of Real Estate Finance and Economics, 27:3, 279±301, 2003
# 2003 Kluwer Academic Publishers. Manufactured in The Netherlands.
Credit History and the Performance of Prime and
Of®ce of Federal Housing Enterprise and Oversight, 1700 G St., N.W., Washington, D.C. 20552, USA
Although nonprime lending has experienced steady or even explosive growth over the last decade very little is
known about the performance characteristics of these mortgages.
Using data from national secondary market institutions, this paper estimates a competing risks proportional
hazard model, which includes unobserved heterogeneity. The analysis examines the performance of 30-year ®xed
rate owner occupied home purchase mortgages from February 1995 to the end of 1999 and compares nonprime
and prime loan default and prepayment behavior. Nonprime loans are identi®ed by mortgage interest rates that are
substantially higher than the prevailing prime rate.
Results indicate that nonprime mortgages differ signi®cantly from prime mortgages: they have different risk
characteristics at origination; they default at elevated levels; and they respond differently to the incentives to prepay
and default. For instance, nonprime mortgages are less responsive to how much the option to call the mortgage or
re®nance is in the money and this effect is magni®ed for mortgages with low credit scores. Tests also reveal that
default rates are less responsive to homeowner equity when credit scores are included in the speci®cation.
Key Words: mortgage, performance, default, prepay, unobserved heterogeneity, credit history, credit curing
In recent years traditional mortgage market participants have made a concerted effort to
increase lending to nonprime borrowers, that is, borrowers who may not qualify for
conventional loans. These borrowers typically pay higher origination fees and interest
rates to re¯ect the higher potential risk of default and prepayment. Data on the
performance of nonprime loans are sparse. While some private companies (for instance,
the Mortgage Information Corporation and University Financial Associates) publish
summary statistics indicating that nonprime loans prepay and default at substantially
higher rates than prime loans, little is known about why this occurs.
Using a competing risk framework that allows for unobserved individual borrower
heterogeneity this paper examines the performance (default and prepay probabilities and
termination rates) of prime and nonprime loans that were originated from February 1995
through February 1998. The simple average from the sample indicates that nonprime
*The views expressed in this research are those of the author's and do not represent policies or positions of the
Of®ce of Federal Housing Enterprise Oversight or other of®cers, agencies, or instrumentalities of the United