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Interest-Rate Changes, Transaction Costs, and Assumable Loan Value

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    Abstract

    This study examines the assumable loan value in creative financing. It is shown that, even in perfect markets and with an identical risk assigned to first and secondary mortgages on the same house, the assumable loan value as determined by the cash equivalence method is overstated. The impact of unexpected changes in market interest rates will reduce the premium paid for the assumable loan. Furthermore, under efficient markets with transaction costs, homebuyers will not pay the value as indicated by traditional cash equivalence for the assumable loan. The buyer's expected payoff could instead be higher by taking a new conventional loan on the house. The result explains some empirical findings of studies using cash equivalence that have found capitalization rates less than 100% of the assumable loan value into home selling prices. Additionally, this paper suggests a theoretical framework that can be used for further research.

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    File URL: http://aux.zicklin.baruch.cuny.edu/jrer/papers/pdf/past/vol02n02/v02p029.pdf
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    Article provided by American Real Estate Society in its journal Journal of Real Estate Research.

    Volume (Year): 2 (1987)
    Issue (Month): 2 ()
    Pages: 29-40

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    Handle: RePEc:jre:issued:v:2:n:2:1987:p:29-40

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    Postal: American Real Estate Society Clemson University School of Business & Behavioral Science Department of Finance 401 Sirrine Hall Clemson, SC 29634-1323
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    Postal: Diane Quarles American Real Estate Society Manager of Member Services Clemson University Box 341323 Clemson, SC 29634-1323
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    Web: http://aux.zicklin.baruch.cuny.edu/jrer/about/get.htm

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    1. Cox, John C. & Ross, Stephen A. & Rubinstein, Mark, 1979. "Option pricing: A simplified approach," Journal of Financial Economics, Elsevier, vol. 7(3), pages 229-263, September.
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