Adjustable Mortgages Research Articles

Horizon Financial Corp.

AbstractCommercial Banking (MIC: 8.1 SIC: 6022 NAIC: 522190)Horizon Financial is a bank holding company. Co., through its subsidiary, Horizon Bank provides an array of commercial and mortgage lending services to borrowers and a range of customer services to depositors through 18 full‐service office facilities, four commercial loan centers and four real estate loan centers, located in Whatcom, Skagit, Snohomish and Pierce counties in Northwest Washington. The Bank originates both fixed rate and adjustable rate mortgages secured by residential, business, and commercial real estate. As of Mar 31 2006, Co. had total assets of $1.12 billion and total deposits of $834.3 million.

Of Note: Home Ownership the Islamic Way: Sharia-Compliant Mortgages in the United States

Of Note:Home Ownership the Islamic Way: Sharia-Compliant Mortgages in the United States Jennifer Murray With as many as 130,000 homeowners facing foreclosure each month in the United States, homeowners with adjustable-rate mortgages worry about making mortgage payments as adjustable rates climb.1 While these adjustable rates understandably cause homeowners sleepless nights, at least most homeowners do not consider their mortgages a sin. For many Muslim would-be homeowners, however, neither a fixed nor an adjustable-rate mortgage is acceptable. Quranic prohibitions against interest (riba)2 and uncertainty (gharar)3 render mortgages available in the United States to be considered forbidden under Islam by many U.S. Muslims.4 Increasingly, U.S. commercial lending institutions are responding to the growing market among Muslims for Sharia-compliant mortgages that satisfy Quranic prohibitions against interest and uncertainty. Pioneer institutions such as LaRiba in California, Guidance Financial Group in Virginia, Devon Bank in Chicago, and University Bank in Ann Arbor, Michigan offer Sharia-compliant mortgages in a majority of U.S. states. Lenders create Sharia-compliant mortgages through several financing mechanisms. Under murabaha financing,5 a lender buys a home on behalf of the homebuyer and sells it to the homebuyer at cost plus a pre-defined profit. The pre-determined profit margin for the lender eliminates interest charges, while a fixed schedule of payments eliminates uncertainty in the contract. Devon Bank claims its murabaha financing allows homeowners to make payments identical to those under a fixed rate mortgage.6 Ijarah-wal-iqtina7 financing is similar to a rent-to-own program in which a lender purchases a home on behalf of a homebuyer, who then buys the property at cost over time while simultaneously paying rent, earning sole ownership of the property upon full payment. Devon Bank likens this arrangement to an adjustable-rate mortgage.8 Musharakah9 financing is another rent-to-own program, but the lender and homebuyer are co-owners of the property. The homebuyer pays rent and part of the principal, with the lender's share in the property diminishing [End Page 93] with every payment made by the homebuyer. Musharakah's co-ownership model also includes profit and loss sharing in the case of the sale of the property.10 Institutions offering these financing instruments must secure sanctioning from Muslim scholars, most often from the Sharia Supervisory Board of America or from prominent scholars such as Sheikh Yusuf Qaradawi and Sheikh Muhammad Taqi Usmani. These new 'Islamic mortgages' expand Muslim home ownership which has lagged behind overall home ownership rates; even in states like Michigan, where the Muslim population has steadily increased over the last ten years, Muslim home ownership rates are as much as seven percent lower than the state average.11 The ability of LaRiba and Devon Bank to partner with the government sponsored enterprise Freddie Mac12 expands the liquidity of these institutions, allowing them to offer more mortgages and increase the possibilities of home ownership for U.S. Muslims. For many Muslims who continued to lease despite their desire to become homeowners, who were forced to save hundreds of thousands of dollars to pay for a home in cash, or who simply swallowed their feelings of guilt and took a regular mortgage,13 these methods of Islamic financing provide a viable, guilt-free alternative to standard mortgages. That sense of peace ensures the market for these mortgages will continue to increase, even as other homeowners suffer sleepless nights. Notes Marks, Alexandra, and Ron Scherer. "As US Foreclosures Mount, States Step In." Christian Science Monitor, April 5, 2007, USA section, page 1. For Quranic passages on riba, see 2:278, 2:275, 2:276, 3:130, 4:161, and 30:039. For Quranic passages on gharar, see 2:219, 5:90. For several examples of Hadith concerning gharar, see Vogel, Frank E., and Samuel L. Hayes, III. Islamic Law and Finance: Religion, Risk, and Return. Edited by Mark S.W. Hoyle. The Hague: Kluwer Law International, 1998. Healy, Patrick O'Gilfoil. "For Muslims, Loans for the Conscience." New York Times, August 7, 2005, section 11, page 1. Murabaha is "resale with specification of gain." Wehr, Hans. The Hans Wehr Dictionary...

Government-Sponsored Enterprises and Resource Allocation: Some Implications for Urban Economies

ing from refinancing, originations can be thought of as the marginal addition to the share in the stock, and the share of the stock can be thought of as the average. Clearly, the secular trend in the stock is mostly the average catching up with the marginal after a break in the marginal in1982. However, originations are not quite the marginal because they do not include payoffs. The more volatile line in the figure depicts the GSE share of growth in the stock, which does correspond to the marginal change in share. While it is more volatile than the origination percentage, it tells a similar story: a break in the early 80s and a recent decline. The difference between marginal and average is important. There is very little trading in used mortgages; mortgages are typically purchased by the GSEs shortly after origination and go into securities. So GSE activity and effect on the market is best viewed in terms of purchases of newly originated loans. Table 1 shows recent changes in product mix in the mortgage market. The key trend since 2001 has been a sharp decline in share of conventional conforming loans (those which are eligible for GSE purchase) and a sharp increase in the share of riskier subprime, AltA (loans between “prime” and subprime) and home equity loans. This has been 7 It is straightforward to show that GSE share of the outstanding stock will rise or fall depending on whether or not the GSE share of the increase in mortgage stock bigger or smaller than the GSE share of the stock. If GSEs have the same principle pay down rate (akin to depreciation rate) as the market as a whole, then share growth will depend on whether or not the GSE share of new originations is bigger or smaller than the GSE share of the stock. Otherwise there needs to be an adjustment for pay down rate differences. In the short run this adjustment can be important, especially in heavy refinancing booms, in part because the GSEs have relatively more fixed rate mortgages, which have more interest sensitive pay down rates than adjustable rate mortgages. 8 The changes in MDO or GSE stock are the difference between two numbers, purchases (or originations) and pay downs, which are both subject to measurement error. The ratio of these numbers can be expected to be quite volatile, especially in years when growth is low. Hence, the year to year volatility is artificially large.

Choice of Mortgage Contracts: Evidence from the Survey of Consumer Finances

This study revisits the empirical question of the determinants of the choice between fixed and adjustable-rate mortgages using more comprehensive data from the Survey of Consumer Finances (SCF) that overcome some of the data limitations in previous studies. The results from a Logit model of mortgage choice indicate that pricing variables and affordability are important considerations. We also find that factors such as mobility expectations, income volatility, and attitudes toward financial risk largely influence mortgage choice, with more risk-averse borrowers preferring fixed-rate mortgages. For households that are less risk averse, the mortgage type choice decision is less sensitive to pricing variables and income volatility, and affordability factors are not significant. These findings provide empirical support that underscore the importance of attitudes toward risks in mortgage choice.

Structural prepayment risk behavior of the underlying mortgages for residential mortgage life insurance in a developing market

Since 1998 all residential mortgages in China have been adjustable rate mortgages (ARMs). However, the borrower’s motivation for prepayment is different from that in the US or other developed mortgage markets. In the US, mortgage insurance plays an imperative role in covering some of the risk typically faced by housing finance institutions. However, China’s residential mortgage life insurance (RMLI) market is in its infancy. It offers the insured mortgagor a life-insurance death benefit, arising from only illness or accident, settling the insured’s outstanding residential mortgage balance. Prepayments of some RMLIs’ underlying mortgages are observed, leading to a premature termination of both the residential mortgage and the insurance commitment to settle the outstanding mortgage balance even though the insured has not yet passed away. Because such prepayments significantly influence the pricing of the RMLI, it is imperative to know more about the prepayment rate of occurrence and the prepayment characteristics of the underlying residential mortgages in terms of observable macro economic factors, loan specific factors and borrower specific characteristics. Hence, this study investigates the prepayment risk behavior of the underlying mortgages for RMLIs, utilizing a pilot study of 1000 Shanghai residential mortgagors who took up RMLIs between January 1999 and December 2003. This study uses the Cox proportional hazard model to investigate RMLI-mortgage prepayment risk behavior. The resultant hazard rate is dependent on four primary factors: combined monthly income of the co-borrowers, growth in the gross domestic product, number of co-borrowers and initial loan-to-value ratio.

Well ARMed and FiRM: Diversification of Mortgage Loans for Homeowners

Individual homeowners are offered today a wide range of mortgage options for financing the purchase of a house. Usually, homeowners are also granted an option to repay the mortgage loan, and in some countries - such as Denmark - it is particularly efficient to do so as market conditions change or the homeowner's situation warrants it. And while, traditionally, a single mortgage loan would serve borrower needs, today it appears that a portfolio of loans may satisfy much better the mortgage needs of the individual and his or her appetite for risk. In this paper we develop a model for the diversification of mortgage loans of a homeowner and apply it to data from the Danish market. Even in the presence of mortgage origination costs it is shown that most risk averse homeowners will do well to consider a diversified portfolio of both fixed (FRM) and adjustable (ARM) rate mortgages. This is particularly so if one takes, unavoidably, a long term perspective in financing the purchase of a home through a mortgage loan.

Do Homeowners Know Their House Values and Mortgage Terms?

To assess whether homeowners know their house values and mortgage terms, we compare the distributions of these variables in the household-reported 2001 Survey of Consumer Finances (SCF) to the distributions in lender-reported data. We also examine the share of SCF respondents who report not knowing these variables. We find that most homeowners appear to report their house values and broad mortgage terms reasonably accurately. Some adjustable-rate mortgage borrowers, though, and especially those with below-median income, appear to underestimate or not know how much their interest rates could change.

Do Homeowners Know Their House Values and Mortgage Terms?

To assess whether homeowners know their house values and mortgage terms, we compare the distributions of these variables in the household-reported 2001 Survey of Consumer Finances (SCF) to the distributions in lender-reported data. We also examine the share of SCF respondents who report not knowing these variables. We find that most homeowners appear to report their house values and broad mortgage terms reasonably accurately. Some adjustable-rate mortgage borrowers, though, and especially those with below-median income, appear to underestimate or not know how much their interest rates could change.

The determinants of mortgage yield spread differentials: Securitization

This paper examines securitization and mortgage yield spread differentials among four groups of Australian mortgage providers: mortgage corporations, commercial banks, building societies and credit unions. The dataset includes over 2000 observations of standard adjustable rate mortgages from 180 institutions. Several studies on the impact of securitization (e.g., reduced funding costs, information costs, agency costs, regulatory tax and improved mortgage marketability and liquidity) can be found, but there is a little empirical evidence, particularly in an Australian context. Our results suggest that mortgage corporations that securitize all their loans have both the narrowest nominal and effective yield spreads among the four groups, consistent with the existing securitization and mortgage cost literature. The regression findings also indicate that both minimum and maximum amounts of loans are significantly associated with spreads.

Valuing Individual Mortgage Servicing Contracts: A Comparison between Adjustable Rate Mortgages and Fixed Rate Mortgages

This study constructs a valuation model from which an option-adjusted spread approach is employed to value individual mortgage servicing contracts for both adjustable rate and fixed rate mortgages. The valuation model is comprised of an exogenous OTS prepayment model, a stochastic interest rate process, and other servicing fees and costs, all of which jointly determine the servicing contract's future net cash flows and the rate at which to discount these cash flows. The sensitivity of the price of mortgage servicing rights to the changes in the economic environment is also analyzed. This work is potentially useful for servicers not only servicing mortgages but also servicing other types of loans in order to examine servicing policy-related issues.

Time in delinquency: implications for mortgage lending and MBS

Delinquency risk is often ignored in recent mortgage-related literature. However, it is postulated to be of sufficient influence to the yields of mortgages and the corresponding mortgage-backed securities (MBS) to warrant concern from mortgage lenders and issuers/underwriters of MBS. This paper provides the a rigorous analysis of the delinquency risk of residential adjustable mortgages (ARMs) by utilizing the ‘time in delinquency’ from delinquency in addition to the conventional delinquency incidence measure. Utilizing the Poisson and negative binomial models on 684 mortgage observations from 1980 to 1999, it is found that uncontrollable environmental factors are essentially responsible for delinquency incidence. However, controllable factors such as occupation of borrower, mortgage term and whether the loan consists of an initial preferential rate period are influential in determining the time in delinquency, if this situation arises. The implication is that although mortgage lenders and MBS underwriters may find that delinquency risk is largely dependent on macroeconomic trends, it may be possible to control and minimize the time in delinquency or the time before reinstatement when delinquency occurred. This is useful in reducing potential losses from default/foreclosure, as, although delinquent borrowers may not have default in mind when they initially miss an instalment, they may find default inevitable if the missed payments were to be allowed to accumulate.

Convention Unites Members In Science and Service

Convention Unites Members In Science and Service

A Note on Hybrid Mortgages

We extend previous research on traditional one-year adjustable-rate mortgages (ARMs) by analyzing the performance of 3/27 hybrid instruments. Under this contract innovation, which first appeared in the mid-1990s, note rates are fixed for three years after which they convert to a traditional one-year adjustment schedule with periodic and lifetime caps. We find high rates of prepayment, particularly at time of initial rate adjustment, and relatively high rates of default, as would be consistent with the payment shock that often affects adjustable-rate loans.

A Note on Hybrid Mortgages

We extend the work of Ambrose and LaCour-Little (2001) on traditional one-year adjustable rate mortgages by analyzing the performance of 3/27 hybrid instruments. Under this contract innovation, which first appeared in the mid-1990s, note rates are fixed for three years after which they convert to a traditional one-year adjustment schedule. We find high rates of prepayment, particularly at time of initial rate adjustment, and relatively high rates of default, as would be consistent with the payment shock that often affects adjustable rate loans.

An ARMs Prepayment Model

This research provides evidence that a parsimonious prepayment speed model, using publicly available resources, can reasonably project prepayment speeds for single-family one-year Fannie Mae ARMs. Two incentives to refinance appear to be the two strongest predictors of projected prepayment speeds for the 1997–2001 period. A 100 basis point increase in the ARM-to-ARM incentive to refinance variable increased prepayment rates by 2.8%, holding other model variables constant. A 100 bp increase in the incentive to refinance from an adjustable-rate mortgage to a fixed-rate mortgage increased the prepayment rate of Fannie Mae-issued single-family ARMs by 2.3%. A limited approach to modeling adjustable-rate mortgages may thus be a cost-effective alternative to costlier and more sophisticated models.

Delinquency Risk in Residential ARMs: A Hazard Function Approach

Executive Summary. Delinquency risk is a major area of concern to mortgage lenders and underwriters of Mortgage-backed Securities (MBS). Utilizing the hazard function approach, this paper provides an analysis of the characteristics and duration of delinquency risk of residential adjustable-rate mortgages (ARMs). Results show that mortgages with average ages of around ten and twelve years have the greatest likelihood of going into delinquency. Results also show that lenders' emphasis on borrower characteristics has been misplaced. Instead, uncontrollable mortgage-specific and macroeconomic characteristics are more significant in affecting delinquency incidence. This critically impairs lenders' ability to mitigate delinquency risk in their mortgage portfolio and hinders MBS underwriters' attempts to package good quality mortgages for securitization.

Delinquency Risk in Residential Arms

Delinquency risk is a major area of concern to real estate mortgage lenders and potential issuers of Mortgage-backed Securities (MBS). This paper provides the first rigorous analysis of residential adjustable mortgage delinquency in Singapore. By studying 633 individual mortgages from 1980 to 1999, it is found that delinquency risk is dominated by macroeconomic factors and several mortgage loan specific factors. In particular, market sentiment, change in mortgage rate and the premium of mortgage over investment rates have a positive influence on delinquency, while change in unemployment rate, capital appreciation of residential properties and housing rentals exerts a negative impact. However, the direction of influence of the change in economic growth is unclear. Generally, property-specific and borrower-specific characteristics do not have a statistical significant impact on delinquency risks. It is also discovered that rate of delinquency and the performance of the economy have a consistently negative relationship. Consistent with the finding that macroeconomic factors exert the greatest impact on delinquency risk, lenders’ abilities to reduce the overall risks of delinquency in their mortgage portfolio are limited. Potential issuers of MBS will also likely find it difficult to package the securities to reduce such risks.

A two-factor, stochastic programming model of Danish mortgage-backed securities

Danish mortgage loans have several features that make them interesting: Short-term revolving adjustable-rate mortgages are available, as well as fixed-rate, 10-, 20- or 30-year annuities that contain embedded options (call and delivery options). The decisions faced by a mortgagor are therefore non-trivial, both in terms of deciding on an initial mortgage, and in terms of managing (rebalancing) it optimally. We propose a two-factor, arbitrage-free interest-rate model, calibrated to observable security prices, and implement on top of it a multi-stage, stochastic optimization program with the purpose of optimally composing and managing a typical mortgage loan. We model accurately both fixed and proportional transaction costs as well as tax effects. Risk attitudes are addressed through utility functions and through worst-case (min–max) optimization. The model is solved in up to 9 stages, having 19,683 scenarios. Numerical results, which were obtained using standard soft- and hardware, indicate that the primary determinant in choosing between adjustable-rate and fixed-rate loans is the short–long interest rate differential (i.e., term structure steepness), but volatility also matters. Refinancing activity is influenced by volatility and, of course, transaction costs.

International Real Estate Review

The prepayment risk of adjustable rate mortgages, unlike that of fixed rate mortgages, greatly depends on the decision of mortgagors to move. Given that housing also serves as an investment asset for the owner, it is hypothesised that the expected capital returns of housing are likely to affect his decision to move and hence, prepay. This paper aims to test the capital gains hypothesis using Singapore’s housing market as a case study. In addition, this paper also explores how the expected returns from alternative types of housing affect the decision of households to move/prepay. The expected returns of housing are computed in accordance with the definitions of the Rational Expectation Hypothesis, Adaptive Expectation Hypothesis, and Exogenous Expectation Hypothesis, which are well established in macroeconomic literature and the explanation of cycles. The results showed that the expected returns of public housing formed under the assumptions of rational and adaptive expectation hypothesis are significant. The rational expected return for private housing, however, does not have a significant relationship with the decision of mortgagors to move/prepay, although the adapted expected return for private housing is not significantly related to the households' length of stay.

Prepayment Risk of Public Housing Mortgages

Executive Summary. This paper examines the determinants of prepayment risk of mortgages for Singapore public housing, which are adjustable rate mortgages. An understanding of the prepayment risk of mortgages is important because prepayments affect investor return from investing in mortgage-backed securities. The findings show that prepayment is positively related to market sentiments and the interest rate of public mortgages. Conversely, it is negatively related to income growth and the relative difference between private and public housing prices. The findings further imply that the prepayment rate of public mortgages is directly affected by any policies that enhance the affordability of residents of public housing to move to private housing.