Mortgage Design in an Equilibrium Model of the Housing Market

Guren, Adam; McQuade, Timothy

doi:10.3386/w24446

Cited by 66 publications

(78 citation statements)

References 15 publications

(19 reference statements)

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“…In these periods, premiums for prepayment options embedded in traditional fixed-rate mortgage rates often increase substantially; thus, the savings of Fixed-COFI mortgages also increase. These rebate dynamics are consistent with mortgages that reduce housing market volatility, consumption volatility, and default, as described by Guren, Krishnamurthy, and McQuade (2017); the key characteristic of such mortgages is immediate and substantial payment relief to liquidity-constrained households during market downturns. Table 4 shows the front-end debt-to-income ratios (DTIs) for the 25 largest MSAs in the United States in 2008:Q3 and2016:Q2.…”

supporting

confidence: 75%

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Financing Affordable and Sustainable Homeownership with Fixed-COFI Mortgages

Passmore¹,

Hafften²

2018

FEDS

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The 30-year fixed-rate fully amortizing mortgage (or "traditional fixed-rate mortgage") was a substantial innovation when first developed during the Great Depression. However, it has three major flaws. First, because homeowner equity accumulates slowly during the first decade, homeowners are essentially renting their homes from lenders. With this sluggish equity accumulation, many lenders require large down payments. Second, in each monthly mortgage payment, homeowners substantially compensate capital markets investors for the ability to prepay. The homeowners might have better uses for this money. Third, refinancing mortgages is often very costly. Expensive refinancing may prevent homeowners from taking advantage of falling rates.To resolve these three flaws, we propose a new fixed-rate mortgage, called the FixedPayment-COFI mortgage (or "Fixed-COFI mortgage"). This mortgage has fixed monthly payments equal to payments for traditional fixed-rate mortgages and does not require a down payment. Also, unlike traditional fixed-rate mortgages, Fixed-COFI mortgages do not bundle mortgage financing with compensation paid to capital markets investors for bearing prepayment risks; instead, this money is directed toward lower monthly payments or toward purchasing the home. The Fixed-COFI mortgage exploits the often-present prepayment-risk "wedges" between the fixed-rate mortgage rate and the estimated cost of funds index (COFI) mortgage rate. In addition, the Fixed-COFI mortgage is a highly profitable asset for many mortgage lenders.We discuss two variations of the Fixed-COFI mortgage. Homeowners with "affordable" Fixed-COFI mortgages are rebated the "wedges" between the traditional fixed-rate mortgage payments and the COFI mortgage payment. After the "wedges" are rebated, these homeowners may pay substantially less to purchase their homes in 30 years than homeowners with traditional fixed-rate mortgages. This mortgage design may help alleviate housing affordability pressures in many areas of the United States.

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supporting

confidence: 75%

“…Guren, Krishnamurthy, and McQuade (2017) find that such mortgages provide immediate and substantial payment relief to liquidityconstrained households during market downturns. In general, interest rates fall following market downturns (due to central bank actions).…”

mentioning

confidence: 93%

Financing Affordable and Sustainable Homeownership with Fixed-COFI Mortgages

Passmore¹,

Hafften²

2018

FEDS

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“…See, e.g.,Agarwal et al, 2017;Berger et al, 2018;Chen, Michaux, and Roussanov, 2018;Davis and Van Nieuwerburgh, 2015;Gorea and Midrigan, 2018;Guren, Krishnamurthy, and McQuade, 2019;Kaplan, Mitman, and Violante, 2017;Li and Yao, 2007;Favilukis, Ludvigson, and Van Nieuwerburgh, 2017).6 This contrasts with the well-known benchmark ofSinai and Souleles (2005) in which these two effects cancel exactly.…”

mentioning

confidence: 98%

Housing Wealth Effects: The Long View

Guren¹,

McKay

Nakamura³

et al. 2020

Preprint

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We provide new time-varying estimates of the housing wealth effect back to the 1980s. We use three identification strategies: OLS with a rich set of controls, the Saiz housing supply elasticity instrument, and a new instrument that exploits systematic differences in city-level exposure to regional house price cycles. All three identification strategies indicate that housing wealth elasticities were if anything slightly smaller in the 2000s than in earlier time periods. This implies that the important role housing played in the boom and bust of the 2000s was due to larger price movements rather than an increase in the sensitivity of consumption to house prices. Full-sample estimates based on our new instrument are smaller than recent estimates, though they remain economically important. We find no significant evidence of a boom-bust asymmetry in the housing wealth elasticity. We show that these empirical results are consistent with the behavior of the housing wealth elasticity in a standard life-cycle model with borrowing constraints, uninsurable income risk, illiquid housing, and long-term mortgages. In our model, the housing wealth elasticity is relatively insensitive to changes in the distribution of LTV for two reasons: First, low-leverage homeowners account for a substantial and stable part of the aggregate housing wealth elasticity; Second, a rightward shift in the LTV distribution increases not only the number of highly sensitive constrained agents but also the number of underwater agents whose consumption is insensitive to house prices.

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“…Furthermore, a fall in the cost of capital that lenders use to supply loans can fuel the speculative use of non-traditional mortgages. The model here borrows heavily from the designs of Barlevy and Fisher (2011) and Relihan (2017) and the insights from other work on the interaction of non-traditional mortgage use and house prices (Campbell and Cocco 2003;Piskorski andTchistyi 2010, 2011;Kung 2015;Guren et al 2018). However, in contrast to this previous work, we allow for a menu of mortgage types to be an endogenous outcome of the model, rather than presupposing a set of available mortgage contract types or focusing on one optimal mortgage design.…”

Section: Theoretical Frameworkmentioning

confidence: 99%

Affordability, Financial Innovation, and the Start of the Housing Boom

Dokko

Keys

Relihan³

2019

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At their peak in 2005, roughly 60 percent of all purchase mortgage loans originated in the United States contained at least one non-traditional feature. These features, which allowed borrowers easier access to credit through teaser interest rates, interest-only or negative amortization periods, and extended payment terms, have been the subject of much regulatory and popular criticism. In this paper, we construct a novel county-level dataset to analyze the relationship between rising house prices and non-traditional features of mortgage contracts. We apply a break-point methodology and find that in housing markets with breaks in the mid-2000s, a strong rise in the use of non-traditional mortgages preceded the start of the housing boom. Furthermore, their rise was coupled with declining denial rates and a shift from FHA to subprime mortgages. Our findings support the view that a change in mortgage contract availability and a shift toward subprime borrowers helped to fuel the rise of house prices during the last decade.

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Mortgage Design in an Equilibrium Model of the Housing Market

Cited by 66 publications

References 15 publications

Financing Affordable and Sustainable Homeownership with Fixed-COFI Mortgages

Financing Affordable and Sustainable Homeownership with Fixed-COFI Mortgages

Housing Wealth Effects: The Long View

Affordability, Financial Innovation, and the Start of the Housing Boom

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