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Mortgage Choice: What's the Point?

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Author Info
Richard Stanton
Nancy Wallace
Abstract

This article shows that, in the presence of transaction costs payable by borrowers on refinancing, it is possible to construct a separating equilibrium in which borrowers with differing mobility select fixed rate mortgages (FRMs) with different combinations of coupon rate and points. We also show that, in the absence of such costs, no such equilibrium is possible. This provides a possible explanation for the large menus of FRMs typically encountered by potential borrowers, and suggests that the menu available at the time of origination should be an important predictor of future prepayment. We numerically implement the model, developing the first contingent claims mortgage valuation algorithm that can quantify the effect of self-selection on real contracts in a realistic interest rate setting. The algorithm allows investors to account for self-selection when valuing mortgages and mortgage-backed securities. It also, for the first time, allows lenders to determine the optimal points/coupon rate schedule to offer to a specified set of potential borrowers, given the current level of interest rates. Copyright American Real Estate and Urban Economics Association.

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File URL: http://www.blackwell-synergy.com/doi/abs/10.1111/1540-6229.00743
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Publisher Info
Article provided by American Real Estate and Urban Economics Association in its journal Real Estate Economics.

Volume (Year): 26 (1998)
Issue (Month): 2 ()
Pages: 173-205
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Handle: RePEc:bla:reesec:v:26:y:1998:i:2:p:173-205

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  1. Joao Cocco & John Campbell, 2004. "Household Risk Management and Optimal Mortgage Choice," Econometric Society 2004 North American Winter Meetings 646, Econometric Society. [Downloadable!]
    Other versions:
  2. John Y. Campbell, 2006. "Household Finance," NBER Working Papers 12149, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  3. Francis A. Longstaff, 2004. "Optimal Recursive Refinancing and the Valuation of Mortgage-Backed Securities," NBER Working Papers 10422, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  4. Francis Longstaff, 2002. "Optimal Recursive Refinancing and the Valuation of Mortgage-Backed Securities," University of California at Los Angeles, Anderson Graduate School of Management 1050, Anderson Graduate School of Management, UCLA. [Downloadable!]
  5. Richard K. Green & Amy Crews Cutts & Buchi Ramagopal, 2006. "Mortgage Contracts and Household Risk Management," Working Papers 0004, School of Business, The George Washington University. [Downloadable!]
  6. Brent Ambrose & Michael LaCour-Little & Anthony Sanders, 2005. "Does Regulatory Capital Arbitrage, Reputation, or Asymmetric Information Drive Securitization?," Journal of Financial Services Research, Springer, vol. 28(1), pages 113-133, October. [Downloadable!] (restricted)
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