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Ong, Sing and Teo (2007) focus on how CPF affects ARM delinquency and default. Campbell and Dietrich (1983) find that most determinants that affect default decisions influence delinquency in the same way. Therefore, the methods and factors used in the literature to rationalize mortgage risks in FRMs serve as a platform for their analysis. Practitioners usually differentiate delinquency and default by the number of days of missed instalments (see Ambrose and Buttimer, 2000). Delinquency is defined as the non-payment of a mortgage paymentdue, while defaultoccurs when a borrower has missed 90 days’ instalment.

As previously mentioned, the unique feature of the mortgage market in Singapore is the use of CPF savings to finance the purchase of residential properties. The protection conferred by regulations to the CPF portion of borrower equity, provides a natural experiment to investigate the role of government and the role of protected borrower equity in controlling mortgage risk.

The data used in the empirical study is based upon a major insurer in Singapore whose business portfolio includes the issuances of residential mortgages. The dataset provides a rich variety of micro-level borrower, loan and property characteristics and consists of 633 random samples of individual housing mortgages. The observations of delinquency and default are taken monthly, from January 1999 to August 2002.

This article postulates that the relationships between equity and delinquency/ defaultrisk can be explained by the conceptof loss aversion among borrowers. When the value of the property falls, the equity component of the mortgage will be reduced first and the current loan-to-value ratio of the mortgage increases. The loss-averse borrower-owner has the incentive to avoid realizing the loss by remaining current in his mortgage. If default occurs, the borrower might be forced to give up his property through foreclosure, and in the process realize the loss in equity.

However, there is a kink in the aforementioned situation. As property value continues to decline, there will be a time when the borrower’s entire equity component is wiped out. When this happens, further declines in property value translate to wealth reduction or financial liability should the owner default or sell the property. At the same time, the protected equity still remains in the borrower’s CPF accountand may be offsetagainstt he liability in future (at the time of retirement). Ong, Sing and Teo (2007) show that protec

ted equity (CPF) committed at loan origination has a positive and significant relationship with delinquency for a given loan-to-value ratio. This is not surprising since a higher CPFto- price ratio represents smaller cash equity for a given loan-to-value ratio (LVR). Not unexpectedly, a higher LVR mortgage is more likely to go into delinquency. Interestingly, a higher LVR mortgage is less likely to lead to default. This is likely to be due to the lack of non-recourse protection in Singapore.

A similar relation holds when the equity-to-value ratio (EVR) is used instead of CPF–to-price ratio. These results suggest that our conventional understanding of the effect of borrower equity on delinquency/default has to be modified for situations where part of the equity is from retirement funds. Hence, borrowers with high EVR can no longer be treated as having lower risks.

For further reading on the relevant factors affecting delinquency risk, please see Teo (2004).