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Embedded Options in the Mortgage Contract

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  • Brent W. Ambrose
  • Richard J. Buttimer Jr.

Abstract

This paper introduces a more detailed specification of the default process on single family residential mortgages: the borrower’s ability to reinstate the mortgage out of default prior to foreclosure. Inclusion of this detail allows for a more thorough analysis of lender loss mitigation programs. We find: Loan forebearance programs which provide borrowers additional time in default lead to higher delinquency rates; however, there is a corresponding increase in the odds of borrower reinstatement. In areas with stable house prices, optimal loss mitigation programs provide provide an economic incentive for the borrower to cure in conjunction with seeking deficiency judgments. Waiving default penalties is not effective in reducing default costs. Borrower assumptions concerning credit reputation significantly impact default and foreclosure. Lenders need to reinforce the impression that default will negatively impact future credit opportunities.

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Bibliographic Info

Paper provided by Wharton School Samuel Zell and Robert Lurie Real Estate Center, University of Pennsylvania in its series Zell/Lurie Center Working Papers with number 305.

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Date of creation: 03 Jul 1998
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Handle: RePEc:wop:pennzl:305

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Cited by:
  1. Brent Ambrose & Anthony Sanders, 2004. "Legal Restrictions in Personal Loan Markets," The Journal of Real Estate Finance and Economics, Springer, vol. 30(2), pages 133-151, November.
  2. Wayne Archer & Brent Smith, 2013. "Residential Mortgage Default: The Roles of House Price Volatility, Euphoria and the Borrower’s Put Option," The Journal of Real Estate Finance and Economics, Springer, vol. 46(2), pages 355-378, February.
  3. David Feldman & Shulamith Gross, 2005. "Mortgage Default: Classification Trees Analysis," The Journal of Real Estate Finance and Economics, Springer, vol. 30(4), pages 369-396, June.
  4. Goodman, Allen C. & Smith, Brent C., 2010. "Residential mortgage default: Theory works and so does policy," Journal of Housing Economics, Elsevier, vol. 19(4), pages 280-294, December.
  5. Tsai, Ming-Shann & Liao, Szu-Lang & Chiang, Shu-Ling, 2009. "Analyzing yield, duration and convexity of mortgage loans under prepayment and default risks," Journal of Housing Economics, Elsevier, vol. 18(2), pages 92-103, June.
  6. Richard J. Buttimer, 2011. "The financial crisis: imperfect markets and imperfect regulation," Journal of Financial Economic Policy, Emerald Group Publishing, vol. 3(1), pages 12-32, February.
  7. Smith, Brent C, 2011. "Stability in consumer credit scores: Level and direction of FICO score drift as a precursor to mortgage default and prepayment," Journal of Housing Economics, Elsevier, vol. 20(4), pages 285-298.
  8. Lynn Fisher & Abdullah Yavas, 2007. "The Value of Equitable Redemption in Commercial Mortgage Contracting," The Journal of Real Estate Finance and Economics, Springer, vol. 35(4), pages 411-425, November.
  9. O. Emre Ergungor, 2009. "Foreclosures in Ohio: does lender type matter?," Proceedings, Federal Reserve Bank of San Francisco, issue Jan.
  10. Seow Ong & Tien Sing & Alan Teo, 2007. "Delinquency and Default in Arms: The Effects of Protected Equity and Loss Aversion," The Journal of Real Estate Finance and Economics, Springer, vol. 35(3), pages 253-280, October.
  11. Katja Hanewald & Michael Sherris, 2011. "House Price Risk Models for Banking and Insurance Applications," Working Papers 201118, ARC Centre of Excellence in Population Ageing Research (CEPAR), Australian School of Business, University of New South Wales.
  12. Youngha Cho & Soosung Hwang & Steve Satchell, 2012. "The Optimal Mortgage Loan Portfolio in UK Regional Residential Real Estate," The Journal of Real Estate Finance and Economics, Springer, vol. 45(3), pages 645-677, October.
  13. Buttimer, Richard Jr. & Lin, Che-Chun, 2005. "Valuing US and Canadian mortgage servicing rights with default and prepayment," Journal of Housing Economics, Elsevier, vol. 14(3), pages 194-211, September.
  14. Lynn Fisher, 2006. "Renegotiation in the Common Law Mortgage and the Impact of Equitable Redemption," The Journal of Real Estate Finance and Economics, Springer, vol. 32(1), pages 61-82, February.
  15. Che-Chun Lin & Ting-Heng Chu & Larry Prather, 2006. "Valuation of Mortgage Servicing Rights with Foreclosure Delay and Forbearance Allowed," Review of Quantitative Finance and Accounting, Springer, vol. 26(1), pages 41-54, February.

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