Neighborhood Characteristics Affect Default Risks

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In March, HUD's Office of Policy Development and Research released Neighborhood Effects in Mortgage Default Risk to evaluate the impact of neighborhood characteristics on Federal Housing Administration (FHA) defaults. This new research distinguishes the effects of neighborhood race, ethnicity, and income from the effects of the individual borrower's status and is in turn distinguished from earlier research by inclusion of credit history.

In general the report finds that low-income neighborhoods and neighborhoods with high population of Blacks are associated with higher rates of default, but the individual borrower's race or income is unrelated to default. The percentage of Hispanics living in an area does not affect default rates. However, when researchers control for characteristics of individual loans, borrowers, and the economic environment, the importance of neighborhood effects dramatically decreases.

The study then examines possible causes for these findings, including whether higher default rates reflect more limited access to mortgage financing or are a response to previous defaults in the neighborhood. Because FHA refinancing rates tend to be higher among loans in tracts with heavier minority (Black or Hispanic) populations, results do not support the idea that racial discrimination in refinancing lies behind race-related neighborhood differences in default probabilities.

The report then explores other possible explanations for the effect of neighborhood income and racial composition on default probabilities. Data from the Chicago metropolitan area reinforce the idea that neighborhood defaults may directly trigger additional defaults and lower neighborhood housing prices that in turn, increase individual default probabilities. These effects may occur because defaults result in vacant properties, leading to neighborhood decay or because they are one component of a perceived undesirable turnover in neighborhood homeownership. The association of higher default rates with minority neighborhoods became insignificant, when past defaults and house price changes were included in the equation, suggesting that lower house price appreciation is an important factor in the higher default rates observed in minority neighborhoods. However, the association of lower income neighborhoods with higher defaults continued to remain significant.

The publication includes 19 tables, including FHA loan counts, defaults, and default rates by race/ethnicity and borrower income for 22 metropolitan statistical areas.

Neighborhood Effects in Mortgage Default Risk is available from HUD USER for $5. Use the order form. The report can also be downloaded from the HUD USER website at www.huduser.gov.