Alternative Mortgage Instruments, the Tilt Problem, and Consumer Welfare

Abstract

mortgage instrument in the United States for the last 50 years, and for much of this period it has performed well. However, during periods of high and volatile rates of inflation, the SFPM suffers from severe weaknesses.1 Foremost among these problems, from the standpoint of the borrower, is the tilt in the stream of real mortgage payments toward the initial years of the mortgage. For consumers unconstrained by capital market imperfections, this tilt is unimportant. However, a consumer is typically unable to borrow against expected higher future income, or against the nominal capital gains that accrue to the owner of a house over the life of the mortgage. In addition, common practices of mortgage lenders often limit mortgage payments to some fraction of income at the time of purchase. Together, these liquidity constraints create a mismatch between the time se? quence of mortgage payments and income, a mismatch that reduces the number of borrowers who qualify for financing and that limits the value of the house purchased by those who do obtain financing.2 In an attempt to reduce the problems created by this mismatch, a variety of alternative mortgage instruments (AMIs) has been suggested. Three of the most important are the Graduated Payment Mortgage (GPM), the Shared-Appreciation Mortgage (SAM), and the Price-Level Adjusted Mortgage (PLAM).3 With the GPM, mortgage payments rise at some specified rate during a portion of the mortgage life. The SAM enables the lender to share in the appreciation of the * University of Colorado, Boulder and Syracuse University, respectively. This paper was writ? ten while the first author was at Syracuse University. Funding for the research was shared by the Office of the Comptroller of the Currency, the Federal Horne Loan Bank Board, and the Department of Housing and Urban Development. Mary Anne Beeman served as research assistant, and the manu?