Payment Mortgage Research Articles

The Lowdown on Low-Down-Payment Mortgages: Is It Safe?

Low down payment mortgages were prevalent before the financial crisis, slowed down during the financial crisis, but have reemerged since the financial crisis. The Federal Housing Administration has a history of insuring 3% down payment mortgages to help lower- and middle-income households purchase a home, but Fannie Mae and Freddie Mac recently have introduced 3% (and lower) down payment programs. In addition, mortgage innovation in the form of the “wealth building mortgage” now adds the possibility of a 100% loan-to-value (LTV) ratio. In this paper, we examine the performance of low down payment (or high LTV) lending. We find that low initial down payment mortgages are significantly more likely to become seriously delinquent (90 days or more) than mortgages with traditional down payments of 20% or more. TOPICS:Fixed income and structured finance, MBS and residential mortgage loans, risk management, credit risk management, legal/regulatory/public policy, financial crises and financial market history Key Findings ▪ This study finds meaningfully accurate estimates of the likelihood of more severe delinquency payment status changes by using individual mortgage loan, borrower, and county-level risk factors as explanatory variables. ▪ Low initial down payment mortgages are significantly more likely to become seriously delinquent (90 days or more) than mortgages with traditional downpayments of 20% or more. ▪ Initial borrower and mortgage characteristics, such as LTV, borrower documentation, or FICO score, are dominant factors in the likelihood of delinquency and default.

The Low Down On Low Down Payment Mortgages: Is It Safe?

Low down payment mortgages were prevalent before the financial crisis, slowed down during the financial crisis, but have reemerged since the financial crisis. The Federal Housing Administration has a history of insuring 3% down payment mortgages to assist lower- and middle-income household in purchasing a home, but Fannie Mae and Freddie Mac have recently introduced 3% (and lower) down payment programs. In addition, mortgage innovation in the form of the “wealth building mortgage” with potentially 100% loan-to-value (LTV) ratio. I this paper, we examine the performance of low down payment (or high LTV) lending. We find that low initial down payment mortgages are significantly more likely to become seriously delinquent (90 days or more) than mortgages with traditional down payments of 20 percent or more.

Home Ownership, Household Leverage, and Hyperbolic Discounting

I examine tenure and mortgage choice in an equilibrium model in which households make decisions as if they discount hyperbolically rather than exponentially. Overall, hyperbolic discounting does not seem to explain the high rates of home ownership or portfolio concentration in housing in the data. I then study the choice between mortgages that require a substantial down payment and mortgages that require no down payment. Allowing households access to no down payment mortgages exacerbates rather than mitigates the undersaving of hyperbolic discounters. However, even when households discount hyperbolically, welfare is higher when households have access to no down payment mortgages.

International Real Estate Review

This paper evaluates the default risk of civil servants’ wage-indexed payment mortgage (WIPM) contract in Turkey, which is linked to the expected inflation. The aim of the study has two sides: one is to apply the contingent claims approach, which has been widely used to price standard fixed- and adjustable-rate contracts, to price an inflation-indexed mortgage. The second is to understand if WIPM contract is a suitable mortgage design for lenders under an inflationary economy. We extend the traditional risk-neutral valuation for pricing the WIPM contract with its embedded default option. Using backward pricing method, namely the explicit finite difference method, we evaluate this unique nflation-indexed mortgage contract from the lender’s point of view. The expected inflation and house price are the two tochastic variables underlying the WIPM contract. Our numerical results show that the lender benefits from originating WIPM only during the periods when the real interest rate is very low. Expected inflation risk premium notably increases the value of future payments on WIPM contract, resulting in high values of lender’s position in the mortgage agreement. The results also show that house price volatility has a greater effect on the borrower’s default option value compared to the expected inflation volatility

Default risk of wage-indexed payment mortgage in Turkey

This paper analyses default risk of wage-indexed payment mortgage (WIPM) in Turkey in comparison with other standard mortgage contracts originated in high inflationary economies. Emlak Bank launched WIPM linked to Civil Service employees’ wage (CSW) index during high inflationary period of late 1990s. Concurrently, the government introduced a policy linking CSW index to semi-annual expected rate of inflation in an attempt to facilitate housing finance for the fastest growing sector of the population. We find that WIPM protects borrowers against risk of high payment shocks whereas nominal contracts such as ARM and DIM would have resulted in high mortgage defaults.

International Real Estate Review

This paper evaluates the Turkish government’s housing policy for financing the public sector housing and examines the desirability of wage-indexed payment mortgage (WIPM) contract from the lenders perspective. The WIPM contract introduced in 1998 differs from the standard index-linked mortgages in that it is based on the Civil Servant’s Wage Index and there is no amortization rate. From the lender’s perspective, the WIPMs are found to be desirable mortgage instruments in periods of persistent high inflation because they eliminate the real interest rate risk and credit risk of the ARM and the ‘wealth risk’ of a nominal FRM.

Valuation of adjustable rate mortgages with automatic stretching maturity

In Hong Kong, 35% of residential mortgage loans are adjustable rate mortgages with variable tenor (VRT). That is, with a change in interest rates, the loan adjusts its maturity and principal payment such that the monthly installment remains the same. In other words, instead of bearing a volatility on monthly payments as in a fixed-tenor variable payment (VRP) mortgage, VRT mortgagors bear interest rate risk by bearing a tenor risk. In this paper, we analyze the valuation of this type of mortgages and the results are compared with the conventional VRP mortgages. We find VRT loans are less expensive from a borrower's perspective than VRP loans, but the difference between the loans becomes less significant if a tenor cap is added to the VRT loan.

An analytical comparison of the durations and price sensitivities of fixed-rate, constant payment and constant amortization mortgages

Both open-form and closed-form formulas are developed to compute duration for two types of fixed-rate mortgages: the level or constant payment mortgage and the constant amortization mortgage. Because holding periods are often less than maturity, duration formulas are also developed for mortgages that are paid prior to maturity. The duration formulas are used to compare the risk and price behavior of the two types of mortgages. Under any scenario, the constant amortization mortgage exhibits less interest rate risk than the constant payment mortgage. The durations of both mortgage types are monotonically increasing functions of maturity when the mortgages are held to maturity. When the mortgages are subject to prepayment, however, durations may, under certain circumstances decline with original maturity.

Duration and the price behavior of fixed-rate level payment mortgages: An analytical investigation

In this research we use a continuous payment formula for duration to examine the price behavior of a fixed-rate level payment mortgage. In the case where the mortgage is held to maturity, duration increases monotonically as term-to-maturity increases, regardless of changes in the market rate of interest. In the case where the mortgage is prepaid prior to maturity, there exists a unique market interest rate below which duration is a monotonically increasing function of time of prepayment, but above which duration has a global maximum at some time of prepayment prior to the term-to-maturity.

Optimal mortgage design when transaction costs constrain mobility

In the presence of transaction costs, purchasers of housing services plan multi-year stays in specific locations by optimizing with regard to present and future preferences, incomes, and prices. In equilibrium, the sum over time of the weighted differences between the marginal rate of substitution and price ratio equals zero. This resembles a public good equilibrium, and the “Lindahl Solution” would call for borrowers to use variable payment mortgages. In this paper we fully develop the concept of an optimal mortgage by using a dynamic model in which transaction costs contrain mobility. We find that variable payment mortgages benefit consumers through reduced transaction costs and benefit the lender through a larger housing purchase earlier in life. A simulation is conducted to validate and quantify these theoretical findings with measures of equivalent and compensating variations. Impediments to Lindahl-type variable payment mortgages are discussed, and solutions are proposed.

A Comparison of the Reinvestment Risk of the Price Level Adjusted Mortgage and the Standard Fixed Payment Mortgage

The purpose of this paper is to increase the understanding of the risk of the indexed mortgage, commonly referred to as the price level adjusted mortgage (PLAM). This is accomplished by comparing, analytically, the reinvestment risk of the PLAM and the standard fixed‐payment mortgage (FPM) under conditions of stochastic inflation and real interest rates. The conclusion is that the PLAM has less reinvestment risk. From the viewpoint of an investor concerned with periodically reinvesting payment streams, the PLAM is the superior mortgage.

The Optimal Mortgage Payment Path Under Price Uncertainty

It has been shown that in a world of certainty, individuals with rising income streams will choose a graduated payment mortgage over the standard flat payment mortgage. The present paper extends this analysis by introducing uncertainty about future inflation rates. We show that the risk‐averse individual, when faced with uncertainty, will choose a less graduated payment path than in the certainty situation. While not conclusive, the analysis may cast some doubt on the suboptimality of the standard flat payment mortgage.

Alternative Mortgage Instruments, the Tilt Problem, and Consumer Welfare

mortgage instrument in the United States for the last 50 years, and for much of this period it has performed well. However, during periods of high and volatile rates of inflation, the SFPM suffers from severe weaknesses.1 Foremost among these problems, from the standpoint of the borrower, is the tilt in the stream of real mortgage payments toward the initial years of the mortgage. For consumers unconstrained by capital market imperfections, this tilt is unimportant. However, a consumer is typically unable to borrow against expected higher future income, or against the nominal capital gains that accrue to the owner of a house over the life of the mortgage. In addition, common practices of mortgage lenders often limit mortgage payments to some fraction of income at the time of purchase. Together, these liquidity constraints create a mismatch between the time se? quence of mortgage payments and income, a mismatch that reduces the number of borrowers who qualify for financing and that limits the value of the house purchased by those who do obtain financing.2 In an attempt to reduce the problems created by this mismatch, a variety of alternative mortgage instruments (AMIs) has been suggested. Three of the most important are the Graduated Payment Mortgage (GPM), the Shared-Appreciation Mortgage (SAM), and the Price-Level Adjusted Mortgage (PLAM).3 With the GPM, mortgage payments rise at some specified rate during a portion of the mortgage life. The SAM enables the lender to share in the appreciation of the * University of Colorado, Boulder and Syracuse University, respectively. This paper was writ? ten while the first author was at Syracuse University. Funding for the research was shared by the Office of the Comptroller of the Currency, the Federal Horne Loan Bank Board, and the Department of Housing and Urban Development. Mary Anne Beeman served as research assistant, and the manu?

A Review and Preliminary Survey of Graduated Payment Mortgagors

AbstractThis paper Is a review of the literature on consumer aspects of the Graduated Payment Mortgage (GPM). It presents the findings of a pilot study designed to assess borrowers’ knowledge of and experiences with the GPM. In the sample of 43 Federal Housing Administration (FHA) Section 245 GPM holders, over one-third were first-time buyers and over one-third were single persons or household heads. The buyers purchased primarily new or nearly-new single-family detached homes at average or lower prices for the locality. The median housing-income ratio was within the range of 30–34 percent.The majority of the loans were five-year graduation plans, with typical annual mortgage payment increases of 5 or 7.5 percent. Mortgagors perceived the final GPM principal to be higher than that for a standard fixed-payment mortgage (SFPM); the GPM interest rate and minimum down payment to be about the same or lower; GPM dosing costs to be about the same; and GPM equity buildup to be slower. Major perceived GPM advantag...

Farm Financial Performance under Graduated Payment Mortgages

Farm Financial Performance under Graduated Payment Mortgages

Does Inflation Affect Real Behavior: The Case of Housing

An important tradition in economics is to assume that demand depends upon relative prices and is homogenous of degree zero. For the most part this has been interpreted as meaning inflation-changes in the price level-leaves demand unchanged. Recent work by a number of economists has challenged this position for the case of housing demand. Two arguments have been made that inflation acting in concert with existing institutions alters the quantity of housing demanded and the decision to rent or own a house. The first argument states that inflation and the standard fixed payment mortgage combine to reduce the size of the mortgage loan a household can obtain for the purpose of buying a home. This works to reduce the quantity of owner-occupied housing demanded given the importance of mortgage finance to the demand for owner-occupied housing. The second argument focuses on the inflation adjusted after-tax cost of owner-occupied housing. It simply states that an increase in the rate of anticipated inflation of the general price level reduces the after-tax cost of housing, thus increasing the demand for housing and the demand for homeownership. There has been little empirical testing of these two arguments. The purpose of this paper is to formulate and estimate a model which will give an indication of the quantitative significance of the two arguments. A housing demand equation and a tenure choice equation (own versus rent) are estimated using a sample of about 6000 households from the 1975 Annual Housing Survey [10]. The estimates suggest that inflation dampens housing demand and homeownership opportunity for most households even though the inflation adjusted after-tax cost of owner-occupied housing declines as inflation heats up. The paper consists of six sections including the introduction. Section Two examines the ways inflation affects housing choices in more detail. The third section contains the specification of the econometric model that forms the basis of the study. Section Four is a discussion of econometric problems and the data used. The results of the estimates are discussed in the fifth section. The paper concludes with a presentation of the major conclusions and policy implications of the study.

Mortgage Policies for Financial Relief in Inflationary Periods

High interest rates pose special problems for the financing of home-ownership. A critical public awareness of these difficulties arose with the record interest rate peaks of early 1980. However, the fundamental problem continues with the more moderate, but still high interest rates that accompany continued inflation. This study examines how a new mortgage instrument could ease the financial strains on borrowers in inflationary periods. The proposed new instrument is a 'deferred mortgage' which a public agency would insure for a fee to the borrower. For comparative purposes, a critical analysis of the existing Graduated Payment Mortgage plan is also undertaken.

Inflation, Mortgage, and Housing

It is hypothesized that constant payment mortgages (imposed, in part, by regulation) lead to distortions in the housing market in the face of anticipated inflation. The nature of this distortion is specified within a model of the housing market. Evidence is presented supporting the existence of the distortion. Moreover, this evidence is found to be robust to various structural and reduced form specifications of the model. A concluding section uses simulation to estimate the total loss to the housing stock up to 1974 attributable to the distortion. It is also shown that the production mix is affected by the inflation-induced distortion.

Simulations of Savings Associations Using Alternative Mortgage Instruments

This paper reports on the development and use of a deterministic, accounting identity, simulation computer model of a federally chartered savings and loan association to observe the effect upon earnings and net worth growth, over the 1964 to 1974 period, of the use of various alternative mortgage instruments. Experiments were conducted on several kinds of variable rate mortgages, graduated payment mortgages, and price level adjusted mortgages; various interest reference rates were tested along with alternative systems of constraining VRM changes, alternative graduation rates, and various systems for paying interest to savers.

Simulation Analysis of Alternative Mortgage Instruments

The widespread concern over the inadequacies of the standard fixed rate, level payment mortgage instrument, especially in inflationary periods, has prompted a number of proposals for alternative mortgage instruments (AMIs). In this study the individual characteristics and economic implications of a number of AMIs are analyzed by simulating their behavior over different types of economic conditions. Each instrument is evaluated on the basis of its relative efficiency in accomplishing its particular objectives. Most of the instruments appear suitable for certain types of borrowers and lenders. However, this limited analysis suggests that the graduated payment and variable rate mortgages have advantages over the other variants considered. Various forms of each are already in use and appear to be relevant and marketable for many of the country's borrowers and lenders.