Types Of Mortgages Research Articles

Unobservable Risk in Mortgage Contract Selection Basket and its Role in Ex-Post Default

This study releases assumptions on previous borrowers’ mortgage choice under information asymmetric: exogenously known default risk and lenders’ zero profit. Through maximizing borrowers’ life-time utilities in housing and non-housing consumption, simulation results show that borrowers’ observable choices basket of mortgage type, preferred LTV, and house size, could reflects unobservable and unverifiable risk factors like real income, wealth, credit worthiness, and housing consumption preference. Further empirical tests, based on individual mortgages from non-agency residential mortgage backed securities, show that some mortgage selection baskets could systematically reflect t unobservable risk factors, which should not be ignored in analyzing mortgagors’ ex-post default. The results also suggest the requirements on understanding borrowers’ incentives and the necessity to gain more borrowers’ information on mortgage’s risk management. This paper might provide broader understanding from individual borrowers’ behaviors at micro-level to explanation on massive defaults in subprime crisis of potential real income story at macro-level.

Macro and Micro Drivers of House Price Dynamics: An Application to Dutch Data

What is the role of micro and macro factors in determining house prices? We address this question by analyzing data on housing and mortgages from a survey of about 2,000 Dutch households over the period 1993–2009. We focus on the determinants of house owners’ subjective assessment of the value of their house, and highlight five main findings. First, house-specific factors, such as location and year of construction, play an important role in house price dynamics. Financing conditions – i.e. the presence of a mortgage, the mortgage type and the mortgage rate paid by households – are also important. Second, household-specific factors which the literature has found to explain the bias of self-reported house values (household income and wealth) have a significant effect on house prices. Third, macroeconomic variables such as long-term interest rates influence to an important extent how households value their home. Fourth, the dynamics of subjective house prices are “well behaved”, both in terms of persistence and mean reversion, indicating that house prices tend to converge to their long run equilibrium value. Finally, we find significant heterogeneity and segmentation of subjective house prices, especially along the dimensions of location, degree of urbanization, funding conditions and households’ income expectations. Overall, our results support the importance of including microeconomic factors in the analysis house price dynamics.

Financial Literacy, Risk Aversion and Choice of Mortgage Type by Households

This paper analyzes how financial literacy and reported willingness to take financial risk impact a household’s choice of mortgage type. The results show that households reporting higher financial literacy and lower risk aversion are 55 to 97 percent more likely to opt for interest-only mortgages. The results are robust to alternative explanations such as the involvement of financial advisors, the effect of peers, experience with prior home-ownership, and house price expectations. In general, alternative mortgage products, as opposed to traditional mortgages, are chosen by wealthier, older, and more sophisticated households that are more likely to have a greater understanding of the risks and benefits associated with these products.

Mortgage Modification Meltdown: When Will Congress Take the Plight of Homeowners Seriously?

Since 2007, over two million families have lost their homes, and studies show that many more millions will lose theirs over the next several years. Even though the crisis has impacted all people across the United States, Hispanic and African-American communities have been considered the “ground zero” of this economic catastrophe, and this problem is coupled with the fact that minorities have generally suffered the greatest job losses as well. Although Congress and the mortgage servicing industry have attempted loan modification reform in the past, many of these efforts have not produced effective results. As part of a multi-pronged approach to combat the foreclosure crisis, the Homes Act adds incentives and extra pressures to encourage mortgage servicers to modify loans, instead of foreclosing on residential property. These provisions involve protecting servicers from TILA liability if they enter into “qualified loss mitigation plans” with homeowners, creating additional TILA disclosure requirements to increase transparency in the secondary mortgage market, and offering payments to servicers if they refinance mortgages in cooperation with the Department of Housing and Urban Development (hereinafter “HUD”) through the Hope for Homeowners program. A judicial approach to the foreclosure crisis is also important, but in passing this bill Congress rejected Senator Dick Durbin’s proposed amendments to the Bankruptcy Code that would have allowed U.S. Bankruptcy Judges to modify residential mortgages in the face of impending foreclosure. It is critical for the federal government and mortgage industry to follow through with this legislation that increases consumer ability to modify home mortgages, in addition to promoting potential judicial mortgage modification authority, in order to stabilize the U.S. housing market. Other strategies for mitigating the foreclosure crisis include promoting the spread of financial information, making significant improvements to the standard mortgage contract, and developing new financial consumer products to reduce the strain upon homeowners who face periods of financial distress. This Note starts by addressing the background of the U.S. home mortgage crisis that began in the latter half of 2007, and continues as of the date of this publication. There follows an examination of a few of the major types of mortgages that exist today, some important past legislation regarding home mortgage lending, and previous failed attempts at reform. Next, this Note analyzes the Homes Act to see if it offers a better source of reform, and compares it to a piece of parallel state legislation from New Jersey. This Note concludes by recommending other avenues for home mortgage modification and reform, including the potential for judicial modification via bankruptcy court, and modern pro-consumer financial products that might alleviate the distressful situation affecting millions of Americans today.

Why is the Market Share of Adjustable-Rate Mortgages so Low?

Over the past several years, U.S. homebuyers have increasingly favored fixed-rate mortgages over adjustable-rate mortgages (ARMs). Indeed, ARMs have dropped to less than 10 percent of all residential mortgage originations, a near-record low. One might speculate that the decline in the ARM share has been driven by one-off factors relating to the financial crisis. However, a statistical analysis suggests that recent trends can largely be explained by the same factors that have historically shaped mortgage choice - most notably, the term structure of interest rates and its effects on the relative price of different types of mortgages. Supply-side factors, in particular a rise in the share of mortgages eligible to be securitized by the housing government-sponsored enterprises, also play a role in the low current ARM share.

Macro and Micro Drivers of House Price Dynamics: An Application to Dutch Data

What is the role of micro and macro factors in determining house prices? We address this question empirically by analysing survey data on housing and mortgages from the DNB Household Survey for the period 1993-2009. We focus on the determinants of house owners' subjective assessment of the value of their house. We highlight three main findings. First, subjective house prices are strongly related to household-specific and house-specific factors, including year of construction, cohort, education level, income and wealth. Financing conditions - in particular the presence of a mortgage as as the mortgage type, and the mortgage rate - play an important role. Second, we find that macro variables such as the long-term interest rate also influence to an important extent how households value their home. Third, there is evidence of well behaved dynamics of subjective house prices, both in terms of persistence and in terms of mean reversion, indicating that house prices tend to converge to their long run equilibrium value. Finally, our findings support a certain degree of heterogeneity and segmentation in subjective house prices, especially along the dimensions of geographical region and degree of urbanization, funding conditions, and income expectations.

Undergraduate Research: Mathematical Modeling of Mortgages

In this article, we study financing in the real estate market and show how various types of mortgages can be modeled and analyzed. With only an introductory level of interest theory, finance, and calculus, we model and analyze three types of popular mortgages with real life examples that explain the background and inevitable outcome of the current financial crisis.

A note on applying option pricing theory to emerging mortgage and mortgage-backed securities markets

Option-based models have been the dominant paradigm for researches on the risks and pricing of mortgages and Mortgage-Backed Securities (MBS) in the USA. However, the adaptability and flexibility of option-based models in the emerging mortgage markets has been obviously neglected. This study provides the first analysis of the potential strengths and weaknesses of application of the option pricing theory to emerging markets with referring to both theoretical and empirical literatures. This study finds that the mortgage type, the attitude of mortgagees to risk and the institutional features are the key determinants of success of application of the option pricing theory to emerging mortgage and MBS markets. The option pricing literature in finance has been extended to study the risks and pricing of mortgages and MBS in the USA over the last three decades. However, given the robust and rapid growth of emerging mortgage and mortgage-related capital markets, there is surprisingly little known about to what extent the option pricing theory can be applied to the emerging mortgage and MBS markets in the global arena. The purpose of this study is to fill this gap by analysing the potential strengths and weaknesses of application of the option pricing models to emerging markets with specifically referring to both theoretical and empirical literatures.

Psychological and Cultural Factors in the Choice of Mortgage Products: A Behavioral Investigation

Using data from three countries that differ economically, culturally, and geographically, this study examines the role of Prospect Theory's reflection effect, a psychological factor, in combination with Uncertainty Avoidance (UA), a cultural factor, on the choice of mortgage products. Experiments were conducted using business professionals in the United States, Germany, and Japan. The results suggest that risk-averse people tend to become more risk seeking, leaning more toward adjustable-rate mortgages (ARMs) when choosing a mortgage type, and that this psychological effect may underlie the mortgage choices of people who tend to choose ARMs, even across countries with different cultures.

Efficient Markets in Crisis

A belief that markets are efficient is blamed for instigating the crisis we are in and lulling us into complacency as the crisis was approaching. But the debate about the role of such belief in the crisis is unfocused for two reasons. First, a lack of a common definition of market efficiency precludes a common language. Second, efficient markets are conflated with free markets.The ambitious definition of efficient markets is their definition as rational markets, where security prices always equal intrinsic values. The modest definition of efficient markets is their definition as unbeatable markets. Bubbles cannot occur in rational markets but they can occur in unbeatable markets. I argue that a belief in market efficiency cannot bear responsibility for our crisis since most investors do not believe that markets are either rational or unbeatable. Free markets are markets where government puts little or no imprint on the financial behavior of individuals and organizations and on markets through regulations and direct intervention. Many advocates of free markets believe that such markets are also more efficient than markets which are not as free. But free markets are distinct from efficient markets. Highly regulated markets can be no less efficient in the sense of rational markets or unbeatable markets than lightly regulated markets. I argue that a belief that free markets are always superior to regulated markets and lightly regulated markets are always superior to heavily regulated markets does bear some responsibility for our crisis. Regulations that would have limited the types of mortgages offered to homeowners would have helped stem the crisis or mitigate it. So would have limits on the degree of leverage employed by banks and homeowners alike.Yet not all regulations and government interventions bring unmitigated benefits. We have no precise measures by which we might distinguish real bubbles from illusory ones. Governments which aim to pop real bubbles run the risk of plunging us into recessions by popping illusory ones. While high P/E ratios and similar measures might alert us to the presence of real bubbles, they are far from precise. The challenge we face is the challenge of seeing an opaque future as clearly as possible, knowing not only that foresight is not as clear as hindsight but also that we would be judged in the future as if it is.

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 data from the Survey of Consumer Finances 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 underscores the importance of attitudes toward risks in mortgage choice.

Optimal prepayment and default rules for mortgage-backed securities

We study the optimal stopping problems embedded in a typical mortgage. Despite a possible non-rational behaviour of the typical borrower of a mortgage, such problems are worth to be solved for the lender to hedge against the prepayment risk, and because many mortgage-backed securities pricing models incorporate this suboptimality via a so-called prepayment function which can depend, at time t, on whether the prepayment is optimal or not. We state the prepayment problem in the context of the optimal stopping theory and present an algorithm to solve the problem via weak convergence of computationally simple trees. Numerical results in the case of the Vasicek model and of the CIR model are also presented. The procedure is extended to the case when both the prepayment as well as the default are possible: in this case, we present a new method of building two-dimensional computationally simple trees, and we apply it to the optimal stopping problem.

Reverse Mortgages: Understanding the Basics

FCS3305, a 7-page fact sheet by Michael S. Gutter, Selena Garrison, Brent Litchfield, and Lisa Leslie, describes this type of tax-free loan that can be used to help fund retirement — requirements, cost considerations, alternatives, types of reverse mortgages, fees and interest, limitations, distribution types, and types of unscrupulous practices. Includes references. Published by the UF Department of Family Youth and Community Sciences, October 2009.

International Real Estate Review

A considerable number of U.S. borrowers still choose adjustable rate mortgages (ARMs) over fixed rate mortgages (FRMs) even when interest rates are historically very low. This study examines the psychological reasons for the popularity of ARMs by testing the Prospect theory’s reflection hypothesis. Experiments are conducted using business professionals. The results suggest that psychological factors may explain why ARM borrowers tend to ignore the associated risk factors, focusing heavily upon pricing factors when choosing mortgage type. The results also indicate that borrowers may be viewing mortgage selection as part of a positive choice; namely, acquiring a home.

How Did We Get Here? The Story of the Credit Crisis

This article examines the problems in the mortgage markets and the subsequent contagion that led to the current credit crisis, and provides a critical analysis of the possible contributing factors. The authors start with the first signs of the credit crisis in the subprime market and describe factors leading to the deterioration of mortgages, including lax underwriting standards, an increase in homeowners9 debt burdens, the combination of low cost of credit and increasing house prices, and the increased use of riskier types of non-traditional mortgages. They then describe the reversal of housing prices and interest rates and signs of a full credit crisis that appeared in 2007. The authors address the controversy over the role of structured financial instruments in the crisis and whether the use of those instruments magnified its impact, with emphasis on collateralized debt obligations (CDOs), credit default swaps (CDSs), and structured investment vehicles (SIVs). Finally, they describe the flight to quality and the freeze in the credit markets. <b>TOPICS:</b>CLOs, CDOs, and other structured credit, financial crises and financial market history

The Risk of Home Mortgages in Italy: Evidence from One Million Contracts

This study analyzes the main characteristics of loans for house purchase issued in Italy between 2004 and 2007 employing the data on individual contracts from the Sample Survey of Lending Rates. Variables describing the type of mortgage and the borrower are related to the ex post probability of late payments and defaults. We also estimate the difference in ex post risk between mortgages that have subsequently been securitized and those that have not. The main results are: variable rate contracts proved to be more risky than fixed rate contracts; the difference is larger for mortgages issued at the end of 2005, when market rates were at their lowest; late payments have been more frequent for borrowers that are younger, resident in the South or immigrants from non-EU countries; non-securitized mortgages were more likely to run into difficulties with late payments and defaults than securitized ones.

Product Innovation &amp; Mortgage Selection in the Subprime Era

The introduction of subprime mortgage lending helped fill an unmet demand for mortgage credit by those who did not qualify for prime credit. The rapid growth of the subprime market provides indirect evidence that there were in the past (before subprime) and probably are again (after the subprime meltdown) many households who cannot purchase a home due to the lack of available mortgage products. Mortgage product innovation has made mortgage terms of art such as io (interest only) or neg-am (negative amortization) part of everyday parlance in the real estate business, but the last few years have also shown that very few institutional investors, underwriters, originators, or servicers fully understood the risks associated with these types of products. If these sophisticated market participants struggled with recent innovations it should come as no surprise that borrowers also struggled to understand them and utilize them effectively. Indeed, the great promise of subprime lending -- making homeownership feasible and an affordable reality for most Americans -- has instead turned into a financial debacle and a massive drag on the American economy.Since the use of exotic or alternative mortgage products played a role in the subprime meltdown, it is important to understand when these products make sense and how far the market deviated from rationality. The research presented here begins this analysis using a county level empirical examination of the mechanisms used to select different types of subprime mortgages from 2000 through July 2007. In particular we examine the use of adjustable rate loans, hybrid rate loans, interest only loans, non-amortizing loans, and loans with balloon payments. The empirical results indicate that the economic and financial incentives play a large part in determining what types of loans people used to finance their home. We also examine how the use of these types of mortgages changed over time and how much of those changes were driven by economic and financial fundamentals. We find substantial evidence of the misallocation of mortgage types over the 2004-2007 time period. This may help us to project what a sensible subprime mortgage market should look like in the future and how far the mortgage market deviated from that path.

Short Rate Models: Hull-White or Black-Karasinski? Implementation Note and Model Comparison for ALM

In this paper, we compare two one-factor short rate models: the Hull White model and the Black-Karasinski model. Despite their inherent shortcomings the short rate models are being used quite extensively by the practitioners for risk-management purposes. The research, as part of students' projects in collaboration with the Asset-Liability-Management (ALM) Group of ABN AMRO Bank, provides detail procedures on the implementation, and assesses model performance from an ALM perspective. In particular, we compare the two models for pricing and hedging Bermudan swaptions because of its resemblance to prepayment option in typical mortgage loans. To our knowledge, the implementation of the two short rate models (and the Black-Karasinski model in particular) is not well documented. We implemented the two models using interest rate derivatives on Euro and US rates over the period February 2005 to September 2007 and with the Hull-White trinomial tree. Our results show that in terms of the in-sample pricing tests, the one-factor Hull-White model outperforms the Black-Karasinski model. The estimated parameters of Hull-White model are also more stable than those of the Black-Karasinski model. On the other hand, the tests for the hedging performance show that the Black-Karasinski model is more effective in hedging the interest rate risk of the at-the-money 10x1 co-terminal Bermudan swaption.

Subprime Mortgages: What, Where, and to Whom?

We explore the types of data used to characterize risky subprime lending and consider the geographic dispersion of subprime lending. First, we describe the strengths and weaknesses of three different datasets on subprime mortgages using information from LoanPerformance, HUD, and HMDA. These datasets embody different definitions of subprime mortgages. We show that estimates of the number of subprime originations are somewhat sensitive to which types of mortgages are categorized as subprime. Second, we describe what parts of the country and what sorts of neighborhoods had more subprime originations in 2005, and how these patterns differed for purchase and refinance mortgages. Subprime originations appear to be heavily concentrated in fast-growing parts of the country with considerable new construction, such as Florida, California, Nevada, and the Washington DC area. These locations saw house prices rise at faster-than-average rates relative to their own history and relative to the rest o

Mortgage Product Innovation in Advanced Economies: More Choice, More Risk

Abstract In many developed countries, house prices have been rising rapidly, mortgage debt has been increasing and affordability has worsened. It is in this context that the standard annuity mortgage is increasingly being supplanted by mortgages with non-standard features, such as longer terms or interest-only payments. Many of these new features aim to reduce the borrower's monthly debt service in the initial period of the loan. While these new mortgage types help households to enter owner-occupation and to vary their expenditure patterns, the long-term cost to the borrower cannot normally be less than for a standard product. Moreover, such mortgages can also be more risky: the interest-only borrower does not accumulate equity as an annuity borrower does, and loans with longer terms expose the borrower to greater risk of interest-rate or other economic shocks. As a result both borrowers pay more and the housing finance system may be more fragile. This paper brings together evidence from 13 developed countries about house prices, debt and affordability, and particularly the availability and market share of mortgages with these new features. It analyses trends over the last ten years and discusses the risks of these mortgages compared to standard annuity products.