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Mortgage Amortization and Amplification

  • Chiara Forlati

    ()

    (Chair of International Finance, Ecole Polytechnique Federale de Lausanne (EPFL), Switzerland)

  • Luisa Lambertini

    ()

    (Chair of International Finance, Ecole Polytechnique Federale de Lausanne (EPFL), Switzerland)

Mortgages characterized by negative or low early amortization schedules amplify the macroeconomic effects of a housing risk shock. We analyze the role of mortgage amortization in a two-sector DSGE model with housing risk and endogenous default. Mortgage loan contracts extend to two periods and have adjustable rates. The fraction of principal to be repaid in the first period can vary. As the fraction of principal to be paid in the first period falls, steady-state mortgages and leverage increase and the impact of a housing risk shock on consumption and output is amplified. Borrowers prefer negative amortization. If free to choose the amortization schedule, borrowers would repay most of the principal in the last period of the contract. Low early repayments of principal allow borrowers to hold on to their housing stock and postpone default to the second period having incurred small sunk costs.

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Paper provided by Center for Fiscal Policy, Swiss Federal Institute of Technology Lausanne in its series Working Papers with number 201201.

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Length: 45 pages
Date of creation: Feb 2012
Date of revision: Feb 2012
Handle: RePEc:cif:wpaper:201201
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  1. Chiara Forlati & Luisa Lambertini, 2011. "Risky Mortgages in a DSGE Model," International Journal of Central Banking, International Journal of Central Banking, vol. 7(1), pages 285-335, March.
  2. Alessandro Calza & Tommaso Monacelli & Livio Stracca, 2013. "Housing Finance And Monetary Policy," Journal of the European Economic Association, European Economic Association, vol. 11, pages 101-122, 01.
  3. Vincent Sterk, 2009. "Credit Frictions and the Comovement between Durable and Non-durable Consumption," DNB Working Papers 210, Netherlands Central Bank, Research Department.
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