The chances of defaults on mortgages made during the fourth quarter of this year are gradually diminishing compared to those originated earlier in this housing downcycle.

According to University Financial Associates (UFA) of Ann Arbor, Michigan, the UFA Default Risk Index for the fourth quarter of 2009 continued its slow retracement from the peak reached in mid-2008. The index’s current reading is 256, which means that nonprime investors and lenders should expect defaults on loans currently being originated to be 156 percent higher than the average of loans originated in the 1990s, the company’s baseline for the analysis.

The fourth quarter assessment is down from last quarter’s revised reading of 264, or a default risk 164 percent higher than loans made in the last decade. According to UFA’s study, the likelihood of default on new mortgages is the lowest it’s been since early 2008.

UFA says its index illustrates the important role that local economic conditions have played in this credit cycle, since loan, borrower, and collateral characteristics are held constant over time in the company’s analysis.

“The economic data this quarter paint a picture of an incipient and balanced recovery from a severe recession,” said Dennis Capozza, professor of finance with the Ross School of Business at the University of Michigan and a founding principal of UFA.

However, Capozza cautioned that particularly for the mortgage industry, this recovery that is being hampered by the lagging indicator – high unemployment.

“Even as house prices move toward sustainable values, and house price depreciation slows, we continue to see high unemployment extending the period of elevated foreclosures,” Capozza said.

The UFA Default Risk Index measures the risk of default on newly originated nonprime mortgages. UFA’s analysis is based on a “constant-quality” loan, that is, a loan with the same borrower, loan, and collateral characteristics. The index reflects only the changes in current and expected future economic conditions, which are much less favorable currently than in prior years.