Forum for Science, Industry and Business

Sponsored by:     3M 
Search our Site:

 

New mortgage design would minimize home foreclosures

20.01.2011
With mortgage loan defaults on the rise yet again, two mortgage researchers are proposing a new type of mortgage contract that automatically resets the balance and the monthly payment based on the mortgaged home's market value.

Brent Ambrose, Smeal Professor of Real Estate and director of the Institute for Real Estate Studies at the Penn State Smeal College of Business, and Richard Buttimer, a professor in the Belk College of Business at the University of North Carolina at Charlotte, call their new mortgage contract the "adjustable balance mortgage" and contend that it reduces the economic incentive to default while costing about the same as a typical fixed-rate mortgage. Under real-world conditions, including the presence of unrecoverable default transaction costs to the lender, this new mortgage contract is better for both lenders and borrowers.

"The threat of foreclosure is not sufficient to prevent widespread default when house prices fall significantly," Ambrose and Buttimer write. "Our new mortgage automatically resets the principle balance at various dates to the minimum of the originally scheduled balance or the value of the house, reducing the borrower's incentive to default if the house value declines."

At origination, the adjustable balance mortgage resembles a fixed-rate mortgage -- it has a fixed contract rate and is fully amortizing. From that point on, at fixed, pre-set intervals, the value of the house would be determined based on changes to a local house price index. If the house value is found to be lower than the originally scheduled balance for that date, the loan balance is set equal to the house value, and the monthly payment is recalculated based on this new value. If the house retains its initial value or increases in value, then the loan balance and payments remain unchanged, just as in a standard fixed-rate mortgage.

For example, if a homeowner was found to owe more than the current market value of her home at one of the predetermined quarterly adjustment dates, then her balance would reset to the current market value and her monthly payment would be lowered as a result. At the next reset interval, if the market had recovered and the house was now worth more than what the homeowner owes, the mortgage balance reverts back to the originally scheduled balance, resulting in a higher monthly payment but one that does not exceed the payment specified at origination.

This new arrangement results in a sharing of the home-price risk between lender and borrower while providing an economic incentive for the borrower to maintain the property even during significant price declines.

"Before the loan balance is reset, the borrower will have lost whatever initial equity they had in the property, plus any equity that they would have built-up through the amortization process," the researchers write. "Should the house price fall below the balance triggering a reset, and the house value then subsequently rises, the lender recovers their lost value first. In addition, if the house value rises above the originally scheduled balance on a reset date, then the owner begins to recover their equity as well."

Through financial modeling and analysis, Ambrose and Buttimer determine that the adjustable balance mortgage would have a lower contract rate than the standard fixed-rate mortgage when the loan-to-value ratio is above 80 percent. Further, they find that their new mortgage provides lenders with an incentive to use a derivative contract to hedge against the risk of home price declines.

According to Ambrose, analysis of this new mortgage provides insight into why the federal loan modification programs are not as successful as expected. The modification plans presented by the U.S. Treasury, Federal Reserve, and FDIC focus strictly on borrower payment-to-income ratios, and, as a result, do not remove the incentive to default for long. In fact, the Office of the Comptroller of the Currency has reported that up to 37 percent of modified mortgages were 60 days into a second default within six months of the modification.

"The only way to truly reduce the default probability is to either reset the mortgage balance to a LTV that is lower than 100 percent, probably around 80 percent, or have frequent, predictable balance resets," Ambrose says. "The key implication is that the programs rolled out by U.S. regulatory authorities will not significantly reduce defaults unless house prices rapidly stabilize or go up, independent of issues such as moral hazard."

"The Adjustable Balance Mortgage: Reducing the Value of the Put" is scheduled for publication in a forthcoming issue of Real Estate Economics.

Wyatt DuBois | EurekAlert!
Further information:
http://www.psu.edu

More articles from Business and Finance:

nachricht Microtechnology industry is hiring – positive developments of past years continue
09.04.2018 | IVAM Fachverband für Mikrotechnik

nachricht RWI/ISL-Container Throughput Index with minor decline on a high overall level
20.03.2018 | RWI – Leibniz-Institut für Wirtschaftsforschung

All articles from Business and Finance >>>

The most recent press releases about innovation >>>

Die letzten 5 Focus-News des innovations-reports im Überblick:

Im Focus: LZH showcases laser material processing of tomorrow at the LASYS 2018

At the LASYS 2018, from June 5th to 7th, the Laser Zentrum Hannover e.V. (LZH) will be showcasing processes for the laser material processing of tomorrow in hall 4 at stand 4E75. With blown bomb shells the LZH will present first results of a research project on civil security.

At this year's LASYS, the LZH will exhibit light-based processes such as cutting, welding, ablation and structuring as well as additive manufacturing for...

Im Focus: Self-illuminating pixels for a new display generation

There are videos on the internet that can make one marvel at technology. For example, a smartphone is casually bent around the arm or a thin-film display is rolled in all directions and with almost every diameter. From the user's point of view, this looks fantastic. From a professional point of view, however, the question arises: Is that already possible?

At Display Week 2018, scientists from the Fraunhofer Institute for Applied Polymer Research IAP will be demonstrating today’s technological possibilities and...

Im Focus: Explanation for puzzling quantum oscillations has been found

So-called quantum many-body scars allow quantum systems to stay out of equilibrium much longer, explaining experiment | Study published in Nature Physics

Recently, researchers from Harvard and MIT succeeded in trapping a record 53 atoms and individually controlling their quantum state, realizing what is called a...

Im Focus: Dozens of binaries from Milky Way's globular clusters could be detectable by LISA

Next-generation gravitational wave detector in space will complement LIGO on Earth

The historic first detection of gravitational waves from colliding black holes far outside our galaxy opened a new window to understanding the universe. A...

Im Focus: Entangled atoms shine in unison

A team led by Austrian experimental physicist Rainer Blatt has succeeded in characterizing the quantum entanglement of two spatially separated atoms by observing their light emission. This fundamental demonstration could lead to the development of highly sensitive optical gradiometers for the precise measurement of the gravitational field or the earth's magnetic field.

The age of quantum technology has long been heralded. Decades of research into the quantum world have led to the development of methods that make it possible...

All Focus news of the innovation-report >>>

Anzeige

Anzeige

VideoLinks
Industry & Economy
Event News

Save the date: Forum European Neuroscience – 07-11 July 2018 in Berlin, Germany

02.05.2018 | Event News

Invitation to the upcoming "Current Topics in Bioinformatics: Big Data in Genomics and Medicine"

13.04.2018 | Event News

Unique scope of UV LED technologies and applications presented in Berlin: ICULTA-2018

12.04.2018 | Event News

 
Latest News

Designer cells: artificial enzyme can activate a gene switch

22.05.2018 | Life Sciences

PR of MCC: Carbon removal from atmosphere unavoidable for 1.5 degree target

22.05.2018 | Earth Sciences

Achema 2018: New camera system monitors distillation and helps save energy

22.05.2018 | Trade Fair News

VideoLinks
Science & Research
Overview of more VideoLinks >>>