Modelling default transitions in the UK mortgage market

Using a large panel data set on the population of UK mortgage loans by Irish-headquartered banks, this paper presents a transitions-based model of mortgage default. The estimation departs from cross-sectional methods typically used in mortgage default models, in that the transition both into and out of mortgage default is predicted. Housing equity, regional unemployment and loan interest rates are found to impact the probability of transition into default, while housing equity, interest rates and the time spent in default all significantly aect the probability that a loan transitions out of default ("cures"). The latter finding is indicative of a hysteresis effect in mortgage markets, whereby the longer a mortgage spends in default, the less likely it is that the obligor will begin repayment. This finding provides important impetus for mortgage modication programmes which aim to tackle mortgage arrears at as early a stage as possible. In an extension, the default transitions of owner-occupiers are shown to be far less sensitive to changes in housing equity than those of Buy-to-Let investors. This finding suggests that instances of "strategic default" are uncommon among UK homeowners, but investors may well exercise the "put option" implicit in their contract when house price falls leave them "out of the money".