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!
How Strong Brands Translate into Money
15.11.2016 | Kühne Logistics University - Wissenschaftliche Hochschule für Logistik und Unternehmensführung
Demographic change depresses tax revenues
04.11.2016 | Fraunhofer-Institut für Angewandte Informationstechnik FIT
In recent years, lasers with ultrashort pulses (USP) down to the femtosecond range have become established on an industrial scale. They could advance some applications with the much-lauded “cold ablation” – if that meant they would then achieve more throughput. A new generation of process engineering that will address this issue in particular will be discussed at the “4th UKP Workshop – Ultrafast Laser Technology” in April 2017.
Even back in the 1990s, scientists were comparing materials processing with nanosecond, picosecond and femtosesecond pulses. The result was surprising:...
Have you ever wondered how you see the world? Vision is about photons of light, which are packets of energy, interacting with the atoms or molecules in what...
A multi-institutional research collaboration has created a novel approach for fabricating three-dimensional micro-optics through the shape-defined formation of porous silicon (PSi), with broad impacts in integrated optoelectronics, imaging, and photovoltaics.
Working with colleagues at Stanford and The Dow Chemical Company, researchers at the University of Illinois at Urbana-Champaign fabricated 3-D birefringent...
In experiments with magnetic atoms conducted at extremely low temperatures, scientists have demonstrated a unique phase of matter: The atoms form a new type of quantum liquid or quantum droplet state. These so called quantum droplets may preserve their form in absence of external confinement because of quantum effects. The joint team of experimental physicists from Innsbruck and theoretical physicists from Hannover report on their findings in the journal Physical Review X.
“Our Quantum droplets are in the gas phase but they still drop like a rock,” explains experimental physicist Francesca Ferlaino when talking about the...
The Max Planck Institute for Physics (MPP) is opening up a new research field. A workshop from November 21 - 22, 2016 will mark the start of activities for an innovative axion experiment. Axions are still only purely hypothetical particles. Their detection could solve two fundamental problems in particle physics: What dark matter consists of and why it has not yet been possible to directly observe a CP violation for the strong interaction.
The “MADMAX” project is the MPP’s commitment to axion research. Axions are so far only a theoretical prediction and are difficult to detect: on the one hand,...
16.11.2016 | Event News
01.11.2016 | Event News
14.10.2016 | Event News
07.12.2016 | Health and Medicine
07.12.2016 | Life Sciences
07.12.2016 | Health and Medicine