Mortgage Supply, LTV and Risk Pricing

Abstract

This paper derives the optimal LTV-ratio for a mortgagee that takes on deposits while it is supplying mortgages using housing as collateral. As the LTV-ratio represents the risk exposure of a mortgagee the optimal LTV-ratio varies according to moral hazard, funding, risk pricing, capital adequacy and lending volumes. Focusing on the supply side of mortgage markets the paper highlights the implications of collateral and the endogenous credit constraint for the LTV-ratio. In the wake of these implications, those on regulations follow naturally. The paper also shows how risk pricing responds to falling house prices and situations where the current LTV-ratio exceeds the LTV-ratio at origination. The relation between the interest rate margin and the LTV-ratio is kinked, distinguishing between risk pricing ex ante and ex post.