Investment characteristics of low- and moderate-income mortgage loans

Abstract

This paper analyzes the investment characteristics of mortgage loans made to low- and moderate-income households. We combine loan level and borrower data provided by a major state housing finance authority with housing transaction data to identify loans terminated by refinancing, moving, and default. We estimate a multinomial logit model for the three risks of early termination. Measures of investment performance are generated using Monte Carlo simulation where the probability of early termination is based on the estimated multinomial model. We randomly select joint interest rate and house price scenarios. For each scenario, we generate the expected cash flows and calculate traditional investment characteristics such as duration and yield spreads. In order to compare the investment characteristics of low- and moderate-income loans with those of conventional mortgages, we simulate the cash flows and investment characteristics of conventional mortgages using models estimated from a major lender’s significantly higher default rate but a significantly lower refinancing rate when interest rates fall. The termination rate from mobility for the low- and moderate-income loans can be higher or lower than that of conventional mortgage loans, depending on the nature of the scenario. Overall, the low- and moderate-income loan portfolio has a longer duration but less negative convexity than the conventitional portfolio.