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Did prepayments sustain the subprime market?

Geetesh Bhardwaj () and Rajdeep Sengupta

No 2008-039, Working Papers from Federal Reserve Bank of St. Louis

Abstract: This paper demonstrates that the reason for widespread default of mortgages in the subprime market was a sudden reversal in the house price appreciation of the early 2000's. Using loan-level data on subprime mortgages, we observe that the majority of subprime loans were hybrid adjustable rate mortgages, designed to impose substantial financial burden on reset to the fully indexed rate. In a regime of rising house prices, a financially distressed borrower could avoid default by prepaying the loan and our results indicate that subprime mortgages originated between 1998 and 2005 had extremely high prepayment rates. However, a sudden reversal in house price appreciation increased default in this market because it made this prepayment exit option cost-prohibitive.

Keywords: Subprime; mortgage (search for similar items in EconPapers)
Date: 2008
New Economics Papers: this item is included in nep-ure
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