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Comparing Present Value Cost Differentials between Fixed- and Adjustable-Rate Loans: A Mortgage Simulation

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  • Tucker, Michael

Abstract

When a borrower chooses between a fixed-rate and an adjustable-rate loan, he is doing so based on expectations of future interest rates and the expected life of the loan. This paper demonstrates how Monte Carlo simulation can be employed to assist in decision making when the borrower is confronted with the choice of fixed- or adjustable-rate mortgages. Present value costs of future mortgage payments are modeled using actual lending parameters offered over a 50-month period, at varying borrower discount rates, and with different mortgage is shown to be sensitive to mortgage holding period and discount rates as well as to market conditions. Copyright 1991 by MIT Press.

Suggested Citation

  • Tucker, Michael, 1991. "Comparing Present Value Cost Differentials between Fixed- and Adjustable-Rate Loans: A Mortgage Simulation," The Financial Review, Eastern Finance Association, vol. 26(3), pages 447-458, August.
    • Handle: RePEc:bla:finrev:v:26:y:1991:i:3:p:447-58
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    Cited by:

    1. Ahn, Kwangwon & Forsyth, Joetta & Jang, Hanwool & Kim, Dongshin, 2022. "Fixed rate mortgages: The cost of interest rate risk aversion," Finance Research Letters, Elsevier, vol. 44(C).
    2. Templeton, William K. & Main, Robert S. & Orris, J. B., 1996. "A simulation approach to the choice between fixed and adjustable rate mortgages," Financial Services Review, Elsevier, vol. 5(2), pages 101-117.
    3. Gregory E. Elliehausen & Min Hwang, 2010. "Mortgage contract choice in subprime mortgage markets," Finance and Economics Discussion Series 2010-53, Board of Governors of the Federal Reserve System (U.S.).
    4. Raymond Chiang & Thomas F. Gosnell & Andrea J. Heuson, 1997. "Evaluating the Interest-Rate Risk of Adjustable-Rate Mortgage Loans," Journal of Real Estate Research, American Real Estate Society, vol. 13(1), pages 77-94.
    5. Philippe Bélanger, 2012. "Assessment of fixed rate mortgage implied insurance cost: Method and ex-post Swiss market analysis," ERES eres2012_372, European Real Estate Society (ERES).

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