Top

The Journal of Real Estate Finance and Economics

Published in:

01-02-2011

Housing Tenure and Mortgage Choice

Authors: Elaine Fortowsky, Michael LaCour-Little, Eric Rosenblatt, Vincent Yao

Published in: The Journal of Real Estate Finance and Economics | Issue 2/2011

Activate our intelligent search to find suitable subject content or patents.

search-config

AI-assisted search

Off

Abstract

This paper examines the relationship between housing tenure and mortgage contract. We present a model showing that, given expected mobility, borrowers will have incentive to self-select into the appropriate mortgage product such that their fixed-rate period is directly related to their probability of moving. We empirically test this hypothesis using housing tenure data derived from a large national database of repeat mortgage transactions. After controlling for borrower characteristics, the mobility hazards of 3/1, 5/1 and 7/1 ARMs, compared to a 30-year fixed rate, are estimated to be 28%, 14% and 11% higher, respectively

previous article A Pricing Model for Residential Homes with Poisson Arrivals and a Sales Deadline

next article Mortgage Brokers and the Refinancing Transaction: Evidence from CRA Borrowers

Dont have a licence yet? Then find out more about our products and how to get one now:

Springer Professional "Wirtschaft+Technik"

Online-Abonnement

Mit Springer Professional "Wirtschaft+Technik" erhalten Sie Zugriff auf:

über 102.000 Bücher
über 537 Zeitschriften

aus folgenden Fachgebieten:

Automobil + Motoren
Bauwesen + Immobilien
Business IT + Informatik
Elektrotechnik + Elektronik
Energie + Nachhaltigkeit
Finance + Banking
Management + Führung
Marketing + Vertrieb
Maschinenbau + Werkstoffe
Versicherung + Risiko

Jetzt Wissensvorsprung sichern!

inform now

Springer Professional "Wirtschaft"

Online-Abonnement

Mit Springer Professional "Wirtschaft" erhalten Sie Zugriff auf:

über 67.000 Bücher
über 340 Zeitschriften

aus folgenden Fachgebieten:

Bauwesen + Immobilien
Business IT + Informatik
Finance + Banking
Management + Führung
Marketing + Vertrieb
Versicherung + Risiko

Jetzt Wissensvorsprung sichern!

inform now

See, for example, Engel and McCoy (2002). Though payment reset is not the source of subprime defaults, argue Foote et al. (2008).

Source: U.S. Census Bureau, Current Population Survey, 2005 Annual Social and Economic Supplement.

Hybrid ARMs are loans that bear fixed rates for 2, 3, 5, 7, or 10 years then convert to a one-year adjustable contract structure for the remainder of a 30 year term. Most subprime loans are either 2 year or 3 year hybrid instruments; however, subprime loans typically have much higher margins that cause the rate to increase significantly during the adjustable rate period; e.g. LIBOR plus six.

Of course, if lenders are required to underwrite loans at the fully-indexed rate, this benefit may disappear.

For completeness we present all contracting possibilities. Clearly some will never be chosen, for example, initiating a FRM in period 2 will always be passed over in favor of initiating a hybrid, which offers the same interest rate risk but with overall lower interest payments.

The formulas are relatively straightforward. One thing that may be worth pointing out is that in most cases it will be optimal for the borrower to switch to an ARM in period 3, realizing the ARM interest rate discount without taking on future interest rate risk (all obligations are terminated in period 3).

We assume the borrower’s distributional assumption for {r ₂, r ₃} is such that every potential re-contracting path gets hit. The key consideration in signing the derivatives is then whether or not the paths unique to a particular product go up or down in probability.

By using the ex-post housing tenure, we assume that the expected tenure (ex-ante) of a representative borrower at origination is an unbiased estimate of actual tenure.

Defined as average debt payments over average income.

In our theoretical framework, factors that affect mobility cannot have an additional, independent effect on mortgage choice. However, such factors are empirically significant so we will appeal to borrower optimization errors to justify our regression model.

During the period under study, the growth of alternative ARM products (3/1, 5/1, 7/1 and 10/1) coincided with the increase in the market of mortgage brokers. Mortgage brokers typically specialized in ARM products and would target borrowers for refinancing at ARM reset dates (see Ambrose and LaCour-Little, 2001).

LaCour-Little and Chun (1998) found that TPOs have economic incentives to encourage borrowers to refinance and accordingly, loans originated by TPOs are significantly more likely to prepay after controlling for other risk factors. Moreover, TP loans are about 3 times as sensitive to refinancing incentives, compared to retail loans.

There is a rich literature in regional science, based on a modified Solow (1956) model, concluding that if immigrant’s human capital levels are higher than natives’ by a sufficient amount, economic growth will be accelerated. The models also predict that a migrant will move either to a place with a higher wage or where the expected stream of wages is higher. Renkow and Hoover (2000) also find that migration is driven by wage differential and housing cost differential between origination and destinations. Therefore, income tends to be highly correlated with mobility.

Ambrose, B. W., & LaCour-Little, M. (2001). Prepayment risk in adjustable rate mortgages subject to initial year discounts: some new evidence. Real Estate Economics, 29(2), 305–328. doi:10.1111/1080-8620.00012.CrossRef

Ambrose, B. W., LaCour-Little, M., & Huszar, Z. R. (2005). A note on hybrid mortgages. Real Estate Economics, 33(4), 765–782. doi:10.1111/j.1540-6229.2005.00138.x.CrossRef

Boehm, T. P. (1981). Tenure choice and expected mobility: a synthesis. Journal of Urban Economics, 10, 375–390. doi:10.1016/0094-1190(81)90008-5.CrossRef

Brueckner, J. K. (1995). Borrower mobility, adverse selection, and mortgage points. Journal of Financial Intermediation, 3, 416–441. doi:10.1006/jfin.1994.1012.CrossRef

Brueckner, J. K., & Follain, J. R. (1988). The rise and fall of the arm: an econometric analysis of mortgage choice. Review of Economics and Statistics, 70, 92–102. doi:10.2307/1928154.CrossRef

Campbell, J. Y., & Cocco, J. (2003). Household risk management and optimal mortgage choice. The Quarterly Journal of Economics, 118(4), 1449–1494. doi:10.1162/003355303322552847.CrossRef

Clapp, J., Goldberg, G., Harding, J., & LaCour-Little, M. (2001). Movers and shuckers: independent prepayment decisions. Real Estate Economics, 29(3), 411–450. doi:10.1111/1080-8620.00017.CrossRef

Dhillon, U., Shilling, J. D., & Sirmans, C. F. (1987). Choosing between fixed and adjustable rate mortgages. Journal of Money, Credit and Banking, 19, 260–267. doi:10.2307/1992281.CrossRef

Engel K, McCoy PA (2002) A tale of three markets: the law and economics of predatory lending. Texas Law Review 80:1255–1367.

Follain, J. R. (1990). Mortgage choice. AREUEA Journal, 18(2), 125–144.

Foote, C., Gerardi, K., Goettea, L., & Willen, P. (2008). Just the facts: an initial analysis of subprime’s role in the housing crisis. Journal of Housing Economics, 17(4), 291–305. doi:10.1016/j.jhe.2008.09.005.CrossRef

Gerardi, K., Rosen, H. S., & Willen, P. (2006). Do households benefit from financial deregulation and innovation? The Case of the Mortgage Market. Federal Reserve Bank of Boston Discussion Paper No. 06-6.

Kiel, K. A. (1994). The impact of house price appreciation on household mobility. Journal of Housing Economics, 3, 92–108. doi:10.1006/jhec.1994.1002.CrossRef

LaCour-Little, M. (2008). Mortgage termination risk: a review of the recent literature. Journal of Real Estate Literature, 16(3), 297–326.

LaCour-Little, M., & Chun, G. H. (1998). Thirty party originators and mortgage prepayment risk: an agency problem? The Journal of Real Estate Research, 17(1/2), 55–69.

Piskorski, T., & Tchisty, A. (2006). Optimal mortgage design. NYU-Stern, Working Paper.

Quigley, J. M. (1987). Interest rate variations, mortgage prepayments, and household mobility. Review of Economics and Statistics, 69(4), 636–643. doi:10.2307/1935958.CrossRef

Renkow, M., & Hoover, D. M. (2000). Commuting, migration, and the nonmetropolitan turnaround. Journal of Regional Science, 40(2), 261–287. doi:10.1111/0022-4146.00174.CrossRef

Sa-Aadu, J., & Sirmans, C. F. (1995). Differentiated contracts, heterogeneous borrowers, and the mortgage choice decision. Journal of Money, Credit and Banking, 27(2), 498–510. doi:10.2307/2077880.CrossRef

Solow, R. M. (1956). A contribution to the theory of economic growth. The Quarterly Journal of Economics, 70(2), 65–94. doi:10.2307/1884513.CrossRef

Stanton, R., & Wallace, N. (1998). Mortgage choice: what’s the point? Real Estate Economics, 26, 173–205. doi:10.1111/1540-6229.00743.CrossRef

Title: Housing Tenure and Mortgage Choice
Authors: Elaine Fortowsky
Michael LaCour-Little
Eric Rosenblatt
Vincent Yao
Publication date: 01-02-2011
Publisher: Springer US
Published in: The Journal of Real Estate Finance and Economics / Issue 2/2011
Print ISSN: 0895-5638
Electronic ISSN: 1573-045X
DOI: https://doi.org/10.1007/s11146-009-9193-z

Springer Professional

Abstract

Please log in to get access to your license.

Dont have a licence yet? Then find out more about our products and how to get one now:

Springer Professional "Wirtschaft+Technik"

Springer Professional "Wirtschaft"

Other articles of this Issue 2/2011

An Estimation of the Coastal Premium for Residential Housing Prices in San Diego County

Collateral Risk in Residential Mortgage Defaults

World Ranking of Real Estate Research: Recent Changes in School Competitiveness and Research Institutions

Mortgage Brokers and the Refinancing Transaction: Evidence from CRA Borrowers

A Pricing Model for Residential Homes with Poisson Arrivals and a Sales Deadline