The Milliman Mortgage Default Index (MMDI) is a lifetime default rate estimate calculated at the loan level for a portfolio of single-family mortgages. For the purposes of this index, default is defined as a loan that is expected to become 180 days or more delinquent over the life of the loan.1 The results of the MMDI reflect the most recent data acquisition available from Freddie Mac and Fannie Mae, with measurement dates starting from January 1, 2014.
With interest rates continuing to rise, mortgage refinance originations, which were at an all-time high in 2021, continued to decline in the second quarter (Q2) of 2022 compared to the first quarter (Q1) of 2022. Meanwhile, mortgage purchase originations saw an increase from 2022 Q1. However, purchase originations are typically higher during Q2, so this increase is not unexpected. When comparing purchase originations to those in 2021, there is still a significant decrease.
The index value of the MMDI was 2.78% for loans originating in 2022 Q2 compared to 2.28% for 2022 Q1 originations. Figure 1 provides the quarter-end index results for these loans, segmented by purchase and refinance. For both purchase and refinance, the primary driver of this increased default risk is an expected slowdown of home price growth over the next several years.
For refinance loans, one driver of increased default risk is the increase of cash-out refinance mortgages. Cash-out refinance loans historically have higher default rates relative to a rate/term refinance, all else equal. Cash-out refinance loans made up about 74% of all refinance loans whereas rate-and-term made up about 26% this quarter. Last year cash-out made up about 34% of refinance loans and rate-and-term made up 66%. Increased cash-out refinance activity as a result of robust home price growth has been a risk trend we have been monitoring since 2020. For more information on cash-out refinances, please see the 2020 Q4 release of the MMDI.
Figure 1: MMDI 2022 Q2 dashboard for GSE loans
Summary of trends
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Our latest MMDI results show that mortgage risk increased for Freddie and Fannie acquisitions over 2022 Q2. There are three components of the MMDI: measures for borrower risk, underwriting risk, and economic risk. Borrower risk measures the risk of the loan defaulting due to borrower credit quality, initial equity position, and debt-to-income ratio. Underwriting risk measures the risk of the loan defaulting due to mortgage product features such as amortization type, occupancy status, and other factors. Economic risk measures the risk of the loan defaulting due to historical and forecasted economic conditions. In 2022 Q2, each of these risk measures were higher than in 2022 Q1.
BORROWER RISK RESULTS: 2022 Q2
For government-sponsored enterprise (GSE) loans, borrower risk increased from 1.43% in 2022 Q1 to 1.58% in 2022 Q2. Purchase loans made up the bulk of loan originations at about 62% of total originations; this is a switch from the last several quarters where refinance loans took up the majority of originations. When compared to refinance loans, purchase loans are correlated with higher borrower risk as it is typical for the borrowers to have lower credit scores and higher loan-to-value ratios. Thus, an increase in borrower risk is expected.
UNDERWRITING RISK RESULTS: 2022 Q2
Underwriting risk represents additional risk adjustments for property and loan characteristics such as occupancy status, amortization type, documentation types, loan term, and others. Underwriting risk after the global financial crisis remains low and is negative for purchase mortgages, which were generally full-documentation, fully amortizing loans. For refinance loans, a greater portion of originations are cash-out refinance loans (as opposed to refinancing for more favorable rate/length-of-loan terms) given recent robust home price growth. Cash-out refinance loans are assigned a greater default risk and are contributing to increases in underwriting risk.
ECONOMIC RISK RESULTS: 2022 Q2
Economic risk is measured by looking at historical and forecasted home prices. Actual home price appreciation has been robust from 2014 through 2022, which has resulted in embedded appreciation for older originations. This results in reduced default risk for older cohorts. For more recent cohorts, we anticipate slower home price growth (or negative growth for some local geographies), which contributes to increases in economic risk for recent origination years.
Figure 2 shows the economic risk component of the MMDI for GSE mortgages as of 2020 Q4, 2022 Q1, and 2022 Q2.
Figure 2: Economic risk by investor and origination
We notice from the chart that economic risk has remained steady for older originations, while economic risk for newer originations has sharply increased as we anticipate slower home price growth in the future. The 2022 Q2 release is relatively consistent with the 2022 Q1 release, which is a stark contrast to the 2020 Q4 release during the height of the COVID-19, when the economic risk was much more uncertain. As previously noted, this publication of the MMDI uses the most recent data available to provide timely information on credit trends.
The MMDI reflects a baseline forecast of future home prices. To the extent actual or baseline forecasts diverge from the current forecast, future publications of the MMDI will change accordingly.
For more detail on the MMDI components of risk, visit milliman.com/MMDI.
About the Milliman Mortgage Default Index
Milliman is expert in analyzing complex data and building econometric models that are transparent, intuitive, and informative. We have used our expertise to assist multiple clients in developing econometric models for evaluating mortgage risk both at the point of sale and for seasoned mortgages.
The Milliman Mortgage Default Index (MMDI) uses econometric modeling to develop a dynamic model that is used by clients in multiple ways, including analyzing, monitoring, and ranking the credit quality of new production, allocating servicing sources, and developing underwriting guidelines and pricing. Because the MMDI produces a lifetime default rate estimate at the loan level, it is used by clients as a benchmarking tool in origination and servicing. The MMDI is constructed by combining three important components of mortgage risk: borrower credit quality, underwriting characteristics of the mortgage, and the economic environment presented to the mortgage. The MMDI uses a robust data set of over 30 million mortgage loans, which is updated frequently to ensure it maintains the highest level of accuracy.
Milliman is one of the largest independent consulting firms in the world and has pioneered strategies, tools, and solutions worldwide. We are recognized leaders in the markets we serve. Milliman insight reaches across global boundaries, offering specialized consulting services in mortgage banking, employee benefits, healthcare, life insurance and financial services, and property and casualty (P&C) insurance. Within these sectors, Milliman consultants serve a wide range of current and emerging markets. Clients know they can depend on us as industry experts, trusted advisers, and creative problem-solvers.
Milliman's Mortgage Practice in Milwaukee is dedicated to providing strategic, quantitative, and other consulting services to leading organizations in the mortgage banking industry. Past and current clients include many of the nation's largest banks, private mortgage guaranty insurers, financial guaranty insurers, institutional investors, and governmental organizations.
1 For example, if the MMDI is 10%, then we expect 10% of the mortgages originated in that month to become 180 days or more delinquent over their lifetimes.