Answer to Question #82685 in Macroeconomics for Leonel

Question

1. Why did housing prices rise rapidly during 2002-2005? Why did the mortgage default rate increase so sharply during 2006 and 2007 even before the current recession began?
2. What happened to the credit standards (e.g. minimum down payment, mortgage loan relative to the value of the house, credit worthiness of the borrower) between 1995 and 2005? Why did the credit standards change? How did this influence the housing price bubble and later the default and foreclosure rates?
3. If owners have little or no equity in their houses, how will this influence the likelihood they will default on their mortgage? Why
4. When did mortgage default and housing foreclosure rates begin to rise rapidly? When did the economy go into the current recession? Was there a causal relationship between the two? Discuss.

Answer 1

1. Housing prices rise rapidly during 2002-2005 according to increase in demand for new houses. The mortgage default rate increased so sharply during 2006 and 2007, because a lot of loans were made with lower standards and more people had no possibility to repay the mortgage.

2. The credit standards (e.g. minimum down payment, mortgage loan relative to the value of the house, credit worthiness of the borrower) between 1995 and 2005 decreased. This influenced the housing price bubble, because it caused increase in demand for mortgages.

3. If owners have little or no equity in their houses, then the likelihood they will default on their mortgage is higher.

4. Mortgage default and housing foreclosure rates begin to rise rapidly in 2007-2008. The economy went into the current recession in 2008. The increase in these rates was one of the main reasons for recession.