Delinquency and Default in Arms: The Effects of Protected Equity and Loss Aversion

Delinquency and Default in Arms: The Effects of Protected Equity and Loss Aversion This paper extends the extant literature in understanding the effects of equity and debt on delinquency and default by focusing on a variant of borrower equity where part of equity is “protected”. The CPF scheme in Singapore stipulates that the refund of borrower’s retirement funds utilized for property purchase prior to September 2002 takes priority over loan obligations. A decision to utilize CPF for property purchase actually increases ex post delinquency and default risk as it effectively reduces cash equity commitment. In particular, any erosion in house value that places protected equity at risk translates into potential wealth reduction or financial liability for the borrower. While loss aversion is evident for non-distressed sellers, the effect of equity losses for distressed borrowers is not as clear. Our research suggests that averting losses in committed equity may be a secondary consideration for borrower subject to income shocks, recognizing that delinquency and default are precursors to foreclosure. Interestingly, we find that the borrowers are strongly averse to incurring protected equity-induced wealth loss or financial liability. This study suggests that the first-lien “anomaly” associated with CPF refund may reduce delinquency and default risks for mortgage backed securities. The Journal of Real Estate Finance and Economics Springer Journals

Delinquency and Default in Arms: The Effects of Protected Equity and Loss Aversion

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Springer US
Copyright © 2007 by Springer Science+Business Media, LLC
Economics; Regional/Spatial Science; Financial Services
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