Adjustable Mortgages Research Articles

Are Adjustable‐Rate Mortgage Borrowers Borrowing Constrained?

Past research argues that changes in adjustable‐rate mortgage (ARM) payments may lead households to cut back on consumption. These outcomes are more likely if ARM borrowers are borrowing constrained, and we show in this article that ARM borrowers exhibit attitudes toward borrowing and behavior that are consistent with being borrowing constrained. Although the demographic and financial characteristics of ARM and fixed‐rate mortgage (FRM) borrowers are somewhat similar, ARM borrowers differ from FRM borrowers in their uses of credit and attitudes toward it. In addition, we find the consumption growth of households with an ARM is more sensitive to past income than the consumption growth of other households, suggesting the ARM borrowers may be subject to borrowing constraints that hinder their ability to smooth consumption.

House-Price Expectations, Alternative Mortgage Products, and Default

August 2013, Revised December 2014 Rapid house-price depreciation and rising unemployment were the main drivers of the huge increase in mortgage default during the downturn years of 2007 to 2010. However, mortgage default was also associated with an increased reliance on alternative mortgage products such as pay-option and interest-only adjustable rate mortgages (ARMs), which allow the borrower to defer principal amortization. The goal of this paper is to better understand the forces that spurred use of alternative mortgages during the housing boom and the resulting impact on default patterns, relying on a unifying conceptual framework to guide the empirical work. The conceptual framework allows borrowers to choose the extent of mortgage “backloading,� the postponement of loan repayment through various mechanisms that constitutes a main feature of alternative mortgages. The model shows that, when future house-price expectations become more favorable, reducing default concerns, mortgage choices shift toward alternative products. This prediction is confirmed by empirical evidence showing that an increase in past house-price appreciation, which captures more favorable expectations for the future, raises the market share of alternative mortgages. In addition, using a proportional-hazard default model, the paper tests the fundamental presumption that backloaded mortgages are more likely to default, finding support for this view.

Simulasi Penghitungan Online Kredit Pemilikan Rumah Bank Xyz Berbasis Web di Portal Finansial www.kontan.co.id

The objective of this study is to develop an online application of mortgage loan simulation. This application is developed based on a web application in order to be accessible anywhere and anytime. This application is expected to help prospective property’s consumers calculate their financial plans related to decisions concerning the amount of down payment, loan term, and the mortgage system model to be selected. There are two models of mortgage in this application. The first is a fixed and cap rate of interest, with the first three years of the mortgage interest rate of 9.75%, the fourth and fifth year interest of 10%, and the sixth year onwards using a rate cap interest with the indication of 12%. The second model is a 2-year fixed rate mortgage with the first two years rate of 8.5% and the third year onwards using adjustable rate mortgage of interest with the indication of 12%. Calculation formula and the interest rates in this application are obtained from Bank XYZ which is in turn applied in collaboration with financial portal www.kontan.co.id. This application has been tested by over 1000 users and the results are well proven and valid.

Diminishing Musharakah as an Alternative to the Conventional Adjustable Rate Mortgage: An Empirical Investigation in to the Viability of an Islamic Equity-Sharing Rent-Based Home-Financing Model

Sufficient evidence remains available for the fact that conventional home-financing methods, that have been used for as long as banking and finance industries have existed, are not feasible structures during turbulent house price periods. Conventional interest-rate and debt based models create very obvious redemption and risk asymmetries that leave either the borrower or the lender financially crippled when property markets collapse. Vast amounts of academic and industry literature have since long proposed equity-based investment structures to mitigate these moral hazards and provide a more feasible risk-return trade-off for both agents in concern. Many such models have previously been tried but were either too closely structured to the conventional lending apparatus or were not applied on a scale large enough to derive any material outcome.This paper investigates a less-popular Islamic rent-based home-finance alternative called the Diminishing Musharakah to test its viability against the conventional Adjustable Rate Mortgage, which on the other hand has been the most preferred form of home-finance for banks and lender institutions worldwide. Historical time-series data on benchmark one-year constant maturity treasury rates, house prices and inflation from six different housing markets is integrated in to an Excel model and, using an inflation-linked imputed rental index, comparative performance tests are run on a total of 1,170 unique data conditions, to examine the risk-return parameters outlining the two distinctive financing models. The results are found to be more or less inconsistent given the mixture variety in data conditions except for periods during extreme downward house price volatility where the Islamic rent-based model consistently outperforms the conventional interest-based model in terms of the mortgagor’s residual equity and equity-on-equity positions. The lender (or financier) is mostly found to benefit from the rent-based model except during some instances of high downward volatility. Overall, the rent-based model seemed to qualify better for quicker equity redemption for the mortgagor or prospective home-owner as such delivering lien-free full home-ownership to him significantly faster than the adjustable rate mortgage.Some key disadvantages were also identified, most of which related to a conceivable increase in risk to the participatory financier. The risk was more income-related than default-related and as such was found to require independent investigation considering the focal premise of this paper being central to default risk during periods of unexpected and extraordinary house price fluctuations. Nevertheless, given the results achieved from the comparative performance assessment it seems unlikely that conventional banks and lender institutions will take to the proposed equity-sharing based model very easily. There is required a significant shift in mindset and consistent large-scale real world practice before any competitive forces compel a structural turnaround that the model advocates, for which the Islamic Finance world plausibly seems to be well-equipped in comparison.

Why do Italian households prefer adjustable rate mortgages?

PurposeIn Italy three quarters of the stock of households' mortgage debt is exposed to interest rate risk. The aim of this paper is to explain why the majority of mortgage holders in the Italian residential mortgage market have chosen a mortgage with a variable interest rate.Design/methodology/approachThe empirical analysis has been carried out on a sample of 959 Italian households on the basis of data from the Survey on Household Income and Wealth by the Bank of Italy and covers the period between 1997 and 2006.FindingsThe outcomes raise some doubts about the efficiency of the Italian mortgage market in terms of risk allocation between banks and householders. Fixed rate mortgage (FRM) versus adjustable rate mortgage (ARM) choice appears to be guided by a short‐term outlook informed by the need to maximize a household's immediate utility. Furthermore, households seem to embrace a myopic perspective, since the preference for ARMs increases with the lengthening of the maturity of the mortgage and with any increase in the size of the principal amount. Also, lending policies appear to have a considerable influence on a household's FRM‐ARM choice.Practical implicationsIt seems that the Italian mortgage market requires adequate initiatives to improve households' financial literacy. Some measures to mitigate the assumption of the interest rate risk by households would be also welcomed.Originality/valueThis study represents the first investigation into the relationship between lending policies of banks and householders' mortgage choice from the perspective of a country distinguished by a high and persistent preference for the adjustable rate mortgages.

Adjustable and fixed interest rates mortgage markets modelling

Due to recent developments in credit markets, the interdependencies among fixed rate mortgages (FRMs) and adjustable rate mortgages (ARMs) markets are analysed in the study of the interactions within credit markets since it appears very suitable and interesting. A meaningful and complete database of information on Financial Institutions in Italy (1997:q1–2011:q4) hold by the Banca d’Italia shows that the relative importance of these markets recently displayed significant fluctuations since in 2005 fixed interest rate mortgage loans were about 10 % while in 2009 they raised up to 70 %. In the context of the FRMs and ARMs characteristics in Italian markets as well as the available database, among the proposed models for the study of interconnected markets (see Brock and Hommes in Econometrica 65(5):1059–1095, 1997, J Econ Dyn Control 22:1235–1274, 1998; Dieci and Westerhoff in Appl Math Comput 215:2011–2023, 2009; J Econ Behav Organ 75(3):461–481, 2010 and related literature cited therein), the models recently developed by Casellina et al. (Comput Econ 38:221–239, 2011) is applied to test its capacity to capture the dynamics of the observed data. It is worth stressing that the involved real data (volume of contracts and average interest rate in the FRMs and ARMs markets) are not sample information but they are evaluated on the entire population. The obtained findings point out the good level to fit the interest rates dynamics. Moreover, the model captures the switching mechanism and it catches the structural breaks when they occurs.

Does Gender Affect Mortgage Choice? Evidence from the US

This study examines the effect of gender on the choice of adjustable- versus fixed-rate mortgages among mortgage applicants in the United States. While adjustable-rate mortgages (ARMs) are initially cheaper, they expose the borrower to interest rate risk. Using linear probability models applied to US lender data for 2004–6, the study finds that the propensity to apply for an ARM among higher-income applicants is lower for women by 3.7–8.4 percentage points or 12–42 percent. Results are robust to the inclusion of education, financial knowledge, and economic determinants of mortgage choice. Results are consistent with past findings of women being more risk averse than men in financial behaviors. Findings of this US-based study are relevant for other countries, as ARMs of varying lengths are widely prevalent outside the US.

Latin Hypercube Sampling and the Identification of the Foreclosure Contagion Threshold

Over the last several years, the U.S. economy has experienced a significant recession brought on by the collapse of the residential real estate market. During this downturn, the number of real estate foreclosures has risen drastically. Recent studies have empirically demonstrated a reduction in real estate values due to neighboring foreclosures, termed the foreclosure contagion effect. The foreclosure contagion effect impacts healthy neighboring properties that surround the foreclosed property as a function of both time and distance. We mathematically specify a precise equation that identifies the foreclosure contagion threshold, that is, the boundary that separates surviving markets from those that crash. Using a new technique to our field known as Latin Hypercube Sampling, we presents the results of a large scale sensitivity analysis to find that beyond the foreclosure discount and disposition time variables, the percentage of adjustable rate mortgages (ARMs) and the foreclosure distance discount weight are the two secondary most contributing causes to a market collapse.

How Homeowners Choose between Fixed and Adjustable Rate Mortgages?

Housing is the most important asset in the portfolio of most households. Understanding the households’ decision on housing finance has important implications from a policy perspective, due to the effects it may have on the housing prices, on the housing market stability and on household welfare. The theoretical literature on housing finance focused on figuring out the optimal choice between Fixed Rate Mortgages (FRM) and Adjustable Rate Mortgages (ARM). We argue that the standard economic criteria are sometimes inadequate to explain household’s choices, which may be motivated by psychological factors. In other words, we claim that household’s choice depends only partially on the findings of the theoretical literature. We examine the effect of changes in the short term market interest rate on the households’ choice between fixed rate mortgages (FRM) and adjustable rate mortgages (ARM). We test this effect using a unique data provided to us by the Bank of Israel, which contains detailed information on the household’s decision between fixed and adjustable rate mortgage contracts in Israel in the past decade. The results of our analysis demonstrate a significant association between FRM preference and short term interest rate reduction. Moreover, we find that the change in the short term interest rate is more salient to the borrowers in periods of a high interest rate environment. We attribute these findings to Tversky and Kahneman (1974) availability and representativeness heuristics.

Mortgage Loan Securitization and Relative Loan Performance

We compare the ex ante observable risk characteristics, the default performance, and the pricing of securitized mortgage loans to mortgage loans retained by the original lender. In our sample of loans originated between 2000 and 2007, we find that privately securitized fixed and adjustable-rate mortgages were riskier ex ante than lender-retained loans or loans securitized through the government sponsored agencies. We do not find any evidence of differential loan performance for privately securitized fixed-rate mortgages. We find evidence that privately securitized adjustable-rate mortgages performed worse than retained mortgages, although other observable factors appear to be more economically important determinants of mortgage default. We do not find any evidence of a compensating premium in the loan rates for privately securitized adjustable-rate mortgages.

Income Risk and Mortgage Choice Among Japanese Households

This paper empirically examines the relationship between income risk and mortgage instrument choice among Japanese households. Since theoretical predictions about the impact of income risks on mortgage choice are mixed, it is important to investigate empirically whether or not risky households borrow ARM loans. In order to answer this question, we construct several measures of income variability and unemployment risk that capture the income risk of the specific household. Our empirical result suggests that these income risk measures are in general negatively associated with the choice of fixed-rate mortgage contract, indicating that risky borrowers are more likely to choose adjustable-rate mortgages. Furthermore, we also find that the impact of income risk on the mortgage choice depends critically on the individual risk preferences. While there is significantly negative impact of income variability and unemployment risk on the mortgage choice for the risk averse borrowers, no systematic relationship can be found for borrowers with low risk aversion.

Optimal Mortgage Contract Choice Decision in the Presence of Pay Option Adjustable Rate Mortgage and the Balloon Mortgage

The unprecedented run-up in global house prices of the 2000s was preceded by a revolution in U.S. mortgage markets in which borrowers faced a plethora of mortgages to choose from collectively known as nontraditional mortgages (NTMs), whose poor performance helped ignite the global financial crisis in 2007. This paper studies the choice of mortgage contracts in an expanded framework where the menu of contracts includes the pay option adjustable rate mortgage (PO-ARM), and the balloon mortgage (BM), alongside the traditional long horizon fixed rate mortgage (FRM) and the short horizon regular ARM. The inclusion of the PO-ARM is based on the fact it is the most controversial and perhaps the riskiest of the NTMs, whereas the BM has not been analyzed in the literature despite its different risk-sharing arrangement and long vintage. Our inclusive model relates the structural differences of these contracts to the horizon risk management problems and affordability constraints faced by the households that differ in terms of expected mobility. The numerical solutions of the model generates a number of interesting results suggesting that households select mortgage contracts to match their horizon, manage horizon risk and mitigate liquidity or affordability constraints they face. From a risk management and welfare perspectives, we find that the optimal contract for households with shorter horizons, specifically households who expect to move house once every 1 to 2 years, is the PO-ARM. Beyond 2 years the welfare advantage of the PO-ARM diminishes and BM becomes the more optimal contract up to 5-year horizon. Overall, the results suggest that households are neither as risk averse as the selection of the FRM would suggest, nor are they as risk-seeking as the selection of PO-ARM or regular ARM would suggest. The results also suggest that the exuberance demonstrated for NTMs by borrowers, especially PO-ARMs, may be both rational and irrational.

What Calls to ARMs? International Evidence on Interest Rates and the Choice of Adjustable Rate Mortgages

The relative popularity of adjustable-rate mortgages (ARMs) and fixed-rate mortgages (FRMs) varies considerably both across countries and over time. We ask how movements in current and expected future interest rates affect the share of ARMs in total mortgage issuance. Using a nine-country panel and instrumental variables methods, we present evidence that near-term (one-year) rational expectations of future movements in ARM rates do affect mortgage choice, particularly in more recent data since 2001. However longer-term (three-year) rational forecasts of ARM rates have a relatively weak effect, and the current spread between FRM and ARM rates also matters, suggesting that households are concerned with current interest costs as well as with lifetime cost minimization. These conclusions are robust to alternative (adaptive and survey-based) models of household expectations.

Borrower characteristics and mortgage rate choice in Sweden

Purpose– The purpose of this paper is to investigate driving forces behind mortgage rate choice among homeowners in a market of no mortgage rate spread. The study reported on was conducted in Sweden, a country relatively spared both from effects of the subprime crisis and the on-going Euro-crisis. A number of potentially influential factors, such as respondents’ risk aversion, financial vulnerability, experience, expectations as well as the impact of media and bank advisors are examined and a number of demographic factors controlled for.Design/methodology/approach– The study reported on is based on data from a national randomized survey conducted in Sweden in 2012. An empirical analysis is carried out on a sample of 474 households with mortgages. A logistic regression is performed to test a model based on hypothesized factors.Findings– The study shows that consumers choosing fixed rate mortgages (FRMs) have high LTV and high risk aversion and perceive their choice as having been influenced by bank advisors. This is in line with earlier findings. Lower levels of – or no – FRMs (more adjustable rate mortgages) seems to be attractive for the wealthier with higher education and previous experience of home owning. Other factor negatively affecting the choice of FRMs are: being younger; being influenced by media; and perceiving oneself as financially vulnerable.Research limitations/implications– To summarize, this paper contributes to research in two major ways: first, the Swedish case is modeled against a review of international research on mortgage rate choice. Second, a number of consumer-related factors are investigated, and their relative contribution as drivers of a choice of FRMs are tested. This gives input to more theoretical research conceptualizing a model for the understanding of how consumer mortgage rate choices are made.Practical implications– The results should serve as an alarm bell for the industry, as the consumers described – the youngest mortgage holders, the financially vulnerable with low repayment capacity and those easily influenced by reports in media – are a potential threat to stable development of long term customer relations and mortgage portfolios.Social implications– The results gives reason for policy makers to address the question and reasons to call for more studies of the preferences and choices of the younger consumers.Originality/value– This study represents an investigation into some factors not often studied in relation to mortgage rate choice. It also highlights the Swedish case and puts it in an international context.

The relationship between consumer characteristics and mortgage preferences

Purpose– The purpose of this paper is to investigate consumer characteristics that influence Swedish consumers’ mortgage rate decisions, such as the choice between an adjustable rate mortgage (ARM) ...

Rethinking Foreclosure Dynamics in a Sunbelt City: What Parcel-Level Mortgage Data Can Teach Us About Subprime Lending and Foreclosures

The dynamics of mortgage foreclosures can be studied by examining parcel-level sales and mortgage data, alongside aggregate data reporting on defaults. This research relies on such microlevel analysis to explore three issues in high-foreclosure census tracts located in Hillsborough County, Florida. First, it notes the prevalence of investor-owners in high-foreclosure areas. Second, it considers the high percentage of adjustable rate mortgages identified in these areas and the frequency with which mortgage defaults occur before interest rate adjustments take effect. Third, it suggests that high levels of investor ownership and extreme volatility of housing and mortgage markets in these neighborhoods complicate the analysis of, and solutions to, the foreclosure crisis.

Payment Size, Negative Equity, and Mortgage Default

Surprisingly little is known about the importance of mortgage payment size for default, as efforts to measure the treatment effect of rate increases or loan modifications are confounded by borrower selection. We study a sample of hybrid adjustable-rate mortgages that have experienced substantial rate reductions over the past years and are largely immune to these selection concerns. We find that payment size has an economically large effect on repayment behavior; for instance, cutting the required payment in half reduces the delinquency hazard by about 55 percent. Importantly, the link between payment size and delinquency holds even for borrowers who are significantly underwater on their mortgages. These findings shed light on the driving forces behind default behavior and have important implications for public policy.

Alternatives to Libor in Consumer Mortgages

Many adjustable rate mortgages in the United States are indexed to Libor. While the accuracy of this rate has recently been called into question, another issue affecting U.S. borrowers has become evident since the onset of the financial crisis. Specifically, many U.S. consumers with Libor-based loans may have been hit with substantially higher payments when their loans reset during the financial crisis than if those loans had been tied to a Treasury rate. We investigate several alternative reference rates for consumer loans and estimate their payment effects on a large sample of Libor-linked U.S. mortgages. We find that these alternatives would have delivered savings over Libor of about $25 to $45 per month and substantially more for mortgages that reset in October 2008.

Banking advice on fixed or adjustable mortgage rates

Since the mid-1990s, Sweden has experienced a period of rapidly rising property prices, and household indebtedness has kept an even pace. The choice between fixed and adjustable interest rates has become increasingly important. This article analyses mortgage rate advice issued by a bank adviser in monthly newsletters during the period 2001–2009, focusing on the content and searching for patterns that may be related to earlier findings. The banking advice is classified into two dimensions: the content and the strength of advice. We find that a large part of the advice suggests that borrowers divide their loans and choose both adjustable and fixed interest rates. Contrary to existing literature, there is no apparent association between the advice provided and interest rate trends (neither short- nor long-term trends). Nor do we find a significant association between the advice and the interest rate gap between fixed and variable rates. This finding implies that the advice in these newsletters was formulated on a rather unclear basis and was of limited use for borrowers.

Analyzing Determinants of Foreclosure of Middle-Income Borrowers of Color in the Atlanta, GA Metropolitan Area

Foreclosures have disproportionately affected borrowers and communities of color. Many studies have concentrated on the nation and specific metropolitan areas, but few academic studies have focused on Atlanta. Using a merged data set consisting of Home Mortgage Disclosure Act (HMDA), U.S. Census, and Lender Processing Services (LPS) data and utilizing a logistic regression model, we analyze the likelihood of foreclosure in the Atlanta, GA metropolitan area. We find that African American borrowers are 52 percent and Hispanic borrowers 159 percent more likely to go into foreclosure, controlling for key financial variables. We also find that African American middle-income borrowers are 35 percent more likely to go into foreclosure. Moreover, we find that exotic mortgage products, such as balloon mortgages, adjustable rate mortgages (ARMs) and mortgages with a prepayment penalty have a higher likelihood of foreclosure than standard 30-year fixed rate mortgages.