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House-price expectations, alternative mortgage products, and default

Author

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  • Jan K. Brueckner
  • Paul S. Calem
  • Leonard I. Nakamura

Abstract

Rapid house-price depreciation and rising unemployment were the main drivers of the huge increase in mortgage default during the downturn years of 2007 to 2010. However, mortgage default was also partly driven by an increased reliance on alternative mortgage products such as pay-option ARMs and interest-only mortgages, which allow the borrower to defer principal amortization. The goal of this paper is to better understand the forces that spurred use of alternative mortgages during the housing boom and the resulting impact on default patterns, relying on a unifying conceptual framework to guide the empirical work.> The conceptual framework allows borrowers to choose the extent of mortgage “backloading,” the postponement of loan repayment through various mechanisms that constitutes a main feature of alternative mortgages. The model shows that, when future house-price expectations become more favorable, reducing default concerns, mortgage choices shift toward alternative contracts. This prediction is confirmed by empirical evidence showing that an increase in past house-price appreciation, which captures more favorable expectations for the future, raises the market share of alternative mortgages. In addition, using a proportional-hazard default model, the paper tests the fundamental presumption that backloaded mortgages are more likely to default, finding support for this view.

Suggested Citation

  • Jan K. Brueckner & Paul S. Calem & Leonard I. Nakamura, 2013. "House-price expectations, alternative mortgage products, and default," Working Papers 13-36, Federal Reserve Bank of Philadelphia.
  • Handle: RePEc:fip:fedpwp:13-36
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    References listed on IDEAS

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    1. John Y. Campbell & João F. Cocco, 2003. "Household Risk Management and Optimal Mortgage Choice," The Quarterly Journal of Economics, Oxford University Press, vol. 118(4), pages 1449-1494.
    2. Michael LaCour‐Little & Jing Yang, 2010. "Pay Me Now or Pay Me Later: Alternative Mortgage Products and the Mortgage Crisis," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 38(4), pages 687-732, Winter.
    3. Keys, Benjamin J. & Mukherjee, Tanmoy & Seru, Amit & Vig, Vikrant, 2009. "Financial regulation and securitization: Evidence from subprime loans," Journal of Monetary Economics, Elsevier, vol. 56(5), pages 700-720, July.
    4. Brueckner, Jan K. & Calem, Paul S. & Nakamura, Leonard I., 2012. "Subprime mortgages and the housing bubble," Journal of Urban Economics, Elsevier, vol. 71(2), pages 230-243.
    5. Brueckner, Jan K, 2000. "Mortgage Default with Asymmetric Information," The Journal of Real Estate Finance and Economics, Springer, vol. 20(3), pages 251-274, May.
    6. Gadi Barlevy & Jonas D. M. Fisher, 2010. "Mortgage choices and housing speculation," Working Paper Series WP-2010-12, Federal Reserve Bank of Chicago.
    7. Posey, Lisa L. & Yavas, Abdullah, 2001. "Adjustable and Fixed Rate Mortgages as a Screening Mechanism for Default Risk," Journal of Urban Economics, Elsevier, vol. 49(1), pages 54-79, January.
    8. João F. Cocco, 2013. "Evidence on the Benefits of Alternative Mortgage Products," Journal of Finance, American Finance Association, vol. 68(4), pages 1663-1690, August.
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    Cited by:

    1. Furlong, Frederick T. & Takhtamanova, Yelena & Lang, David, 2016. "Mortgage Choice: Interactive Effects of House Price Appreciation and Mortgage Pricing Components," Working Paper Series 2016-28, Federal Reserve Bank of San Francisco.

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    Keywords

    Mortgage loans ; Mortgages;

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