When cyclones and floods strike populated areas, people’s ability to meet mortgage payments varies significantly depending on the severity and type of extreme weather, recent research suggests. The study found that more powerful cyclones increase the likelihood of borrowers missing or delaying mortgage payments. Similarly, heavy rainfall, especially in flood-prone coastal regions, heightens the risk of defaulting on payments or discouraging early mortgage repayment.
As climate change exacerbates the frequency and intensity of extreme weather events, the role of this research in enhancing predictive capabilities becomes increasingly crucial for major financial institutions and borrowers alike. Researchers from the University of Edinburgh analyzed data from nearly 70,000 mortgages and over 3.5 million individual payments to assess how heavy rains and tropical cyclones impact mortgage risk in Florida, USA. By combining detailed mortgage characteristics and payment histories with meteorological data, they aimed to empower lenders with better predictive capabilities regarding payment defaults and early mortgage repayments.
Their findings highlight that the intensity of tropical cyclones significantly affects the likelihood of borrowers defaulting on their payments. For instance, hurricanes of category three or higher more than doubled the probability of default compared to category two storms. Additionally, the study revealed that heavy rains in flood-prone areas reduce the likelihood of borrowers opting for early mortgage repayment. However, tropical cyclones themselves did not significantly influence this behaviour.
These outcomes carry negative consequences for both lenders and borrowers. Defaulting damages borrowers’ credit scores, while early repayment affects lenders’ expected cash flows, according to the researchers. The study’s innovative credit scoring models, incorporating weather-related variables, demonstrated a notable improvement in predicting mortgage defaults and prepayments. Professor Raffaella Calabrese from the University of Edinburgh Business School stressed the importance of systematically integrating weather-related risks into credit risk assessments. She underscored that such adaptations are essential for accurately assessing the evolving risks posed by extreme weather events.
The research underscores the critical necessity for financial institutions to adapt their risk assessment frameworks to include the growing impact of climate change-induced extreme weather events on mortgage payments and loan behaviours. This proactive approach not only enhances predictive accuracy but also strengthens resilience against future financial risks stemming from climate variability, making it a vital step for the financial industry.
More information: Raffaella Calabrese et al, Impacts of extreme weather events on mortgage risks and their evolution under climate change: A case study on Florida, European Journal of Operational Research. DOI: 10.1016/j.ejor.2023.11.022
Journal information: European Journal of Operational Research Provided by The University of Edinburgh