Issues in Mortgage Design
Friday, Jan. 6, 2017 1:00 PM – 3:00 PM
- Chair: Anthony Sanders, George Mason University
Automatic Workout Mortgage and Housing Consumption Choice
AbstractThis paper proposes an innovative mortgage contract with an endemic insurance to alleviate negative equity, systemic risk and revive the economy. We term this as an Automatic Workout Mortgage (AWM) and model it mathematically. Our efforts yield the following results. Demand for housing increases if AWM is employed and attains maxima for those intending to reverse-mortgage 40% of equity (without workout) and about 80% of equity (with AWM). We therefore assert that AWM is particularly suited for those who intend to sell or reverse-mortgage a significant fraction of their home equity before retirement. Insurance provided via AWM inhibits precautionary saving motives by making housing more attractive to risk averse borrowers. Consumption is reduced as more housing is purchased and borrowing increased. AWM improves expected utility by a dollar equivalent of about 38% to 56% of the initial value of the house $100,000. AWM protect the value acumulated in the home equity and thus facilitate future migration to a more suitable property. In this respect AWMs also improve future housing affordability, especially at the retirement age.
Making Homeownership More Accessible by Improving the Fixed-Rate Mortgage
When it was first developed over 50 years ago, the 30-year fixed-rate fully-amortizing mortgage (or “traditional fixed-rate mortgage”) represented a substantial innovation in the mortgage market; however, it has three major flaws. First, since homeowner equity accumulates slowly during the first decade, homeowners are essentially renting their homes from lenders. With so little equity accumulation, many lenders require large down payments. Second, in each monthly mortgage payment, homeowners substantially compensate capital markets investors for the ability to prepay. The homeowner might have better uses for this money. Finally, refinancing mortgages is often very costly.
I propose a new fixed-rate mortgage, which is called the fixed-payment-COFI mortgage (or “the fixed-COFI mortgage”), that resolves the three problems with the traditional fixed-rate mortgage. This mortgage has fixed monthly payments equal to payments for traditional fixed-rate mortgages and no down payment. Also, unlike traditional fixed-rate mortgages, fixed-COFI mortgages do not bundle mortgage financing with insurance products to compensate capital markets investors for bearing prepayment risks; products many homeowners do not need.
The fixed-COFI mortgage exploits the often-present prepayment-risk wedge between the fixed-rate mortgage rate and the estimated cost of funds index (COFI) mortgage rate. Committing to a savings program based on the difference between fixed-rate mortgage payments and payments based on COFI plus a margin, the homeowner uses this wedge to accumulate home equity quickly. In “normal” times, the fixed-COFI mortgage leads to rapid home equity accumulation by the household (almost always resulting in homeownership) and remains a highly profitable asset for the mortgage lender.
The fixed-COFI mortgage may help renters, who are paying rents as high as comparable mortgage payments in high-cost metropolitan areas and do not have enough savings for a down payment, gain access to homeownership
Does Differential Treatment Translate to Differential Outcomes for Minority Borrowers? Evidence from Matching a Field Experiment to Loan-Level Data
AbstractThis paper provides evidence on the relationship between differential treatment of minority borrowers and differential loan outcomes in the mortgage market. Using data from a field experiment that identifies differential treatment matched to real borrower transactions in the Home Mortgage Disclosure Act (HMDA) data, we estimate difference-in-difference models between African American and white borrowers across lending institutions that display varying degrees of differential treatment. Our results show that African Americans are more likely to be in a high cost (sub-prime) loan when borrowing from lenders that are more responsive to them in the field experiment. We also show that net measures of differential treatment are not related to the probability of African American borrowers having a high cost loan. Our results suggest that differential outcomes are related to within institution factors like client steering, not just across institutional factors like access as previous studies find.
- G2 - Financial Institutions and Services
- J1 - Demographic Economics