Home Price Drop, Subprime Status Indicate Foreclosure

The equity in a home and whether a loan is subprime or prime are the major indicators of the risk of foreclosure, Paul Willen, senior economist and policy advisor for the Federal Reserve Bank of Boston, said Friday at the Federal Reserve Bank of Chicago’s Annual Conference on Bank Structure and Competition.

Negative home appreciation and a rise in the subprime purchase market had a major impact on recent foreclosures in Massachusetts, according to Willen. “Increased activity in the subprime purchase mortgage market created a large class of vulnerable buyers.”

The probability of a Massachusetts subprime borrower facing foreclosure is greater than 18 percent, compared to only 3 percent for prime mortgage borrowers, Willen said.

If equity is positive almost no one defaults because they can sell at a profit, Willen said. If the equity is negative, then default may occur, but the chance of default depends on a number of other factors – the amount of negative equity, local market conditions and macroeconomic factors.

A homeowner may keep his property when he has negative equity, as long as he can financially outlast the market downturn, with the idea that he will make money eventually. The larger question is whether the homeowner has the financial resources to outlast the market downturn, Willen said.