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A model of mortgage default

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  • Campbell, John Y.
  • Cocco, João F.

Abstract

This paper solves a dynamic model of households' mortgage decisions incorporating labor income, house price, inflation, and interest rate risk. It uses a zero-profit condition for mortgage lenders to solve for equilibrium mortgage rates given borrower characteristics and optimal decisions. The model quantifies the effects of adjustable vs. fixed mortgage rates, loan-to-value ratios, and mortgage affordability measures on mortgage premia and default. Heterogeneity in borrowers' labor income risk is important for explaining the higher default rates on adjustable-rate mortgages during the recent US housing downturn, and the variation in mortgage premia with the level of interest rates.

Suggested Citation

  • Campbell, John Y. & Cocco, João F., 2014. "A model of mortgage default," CFS Working Paper Series 452, Center for Financial Studies (CFS).
    • Handle: RePEc:zbw:cfswop:452
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    More about this item

    Keywords

    household finance; loan to value ratio; loan to income ratio; mortgage affordability; negative home equity; mortgage premia;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth

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