What Homebuyers Need to Know about the Differential Risk of Mortgages

Because homeownership represents the largest investment many individuals make, and the credit risks of competing mortgage products are not well understood, we develop a framework to quantify absolute and relative credit risks of mortgage products. We use simulations to examine the default rates of five types of mortgage products under both a normal and stressed economy to examine relative risk differences among the competing mortgage products. Results suggest that some mortgage products have a default risk four times larger than fixed-rate loans and default probabilities of 30% in a stressed economy. As a result, homebuyers should consider the credit risk of competing mortgage products before selecting a mortgage.