Abstract
I explore an alternative mortgage contract that limits negative equity by tying outstanding debt to an index of house prices. This is done in an incomplete markets model, that is calibrated to match US micro- and macro-data. I find that switching from a non-recourse contract to an indexed contract reduces the default rate from .72% to .11% and expands homeownership rates among the young and the poor but pushes up the equilibrium base mortgage rate by 90 basis points. The volatility of net cashflows to financial intermediaries also increases slightly under the new contract.
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