Why Do Homeowners Make Mortgage Curtailment Payments?

How do Interest Rate Changes Affect Mortgage Curtailments? Evidence from China

“…In this subsection, we examine whether the responsiveness of mortgage curtailments depends on the direction of the change in the interest rate. The interest rate risk of ARMs resides in the reset of the interest rate to a higher level (Adelman, Cross and Shrider 2010). If the response of mortgage curtailments is driven by the borrowers’ desire to reduce interest rate risk, we should observe a stronger response to interest rate increases than to decreases.…”

“…They also argue that collecting and incorporating curtailment information could help investors with the pricing and hedging of a seasoned mortgage‐backed security. Using data from the Federal Reserve's Survey of Consumer Finances, Adelman, Cross and Shrider (2010) investigate why homeowners make mortgage curtailments and find that the propensity to save is the most powerful and significant factor in predicting the probability of curtailment. McCollum, Lee and Pace (2015) show that mortgage curtailment experienced significant increase from 2001 to 2011 and has been a fairly common behavior for U.S. homeowners since 2006.…”

“…1 The studies on mortgage curtailment behavior are still limited, with most of them focusing on the importance of curtailment ( e.g ., Hayre and Lauterbach 1991, Chinloy 1993, Lin et al . 2005) and its determinants ( e.g ., Budinger and Fan 1995, Adelman, Cross and Shrider 2010). Meanwhile, although an extensive literature exists on the role of the interest rate in the full prepayment of a mortgage, rarely has the research examined how this rate affects the borrower's curtailments (partial prepayments).…”

“…The view of interest rate risk focuses on borrowers’ incentives to mitigate this risk. ARM borrowers face the risk that their mortgage rates might be adjusted to a higher level (Adelman, Cross and Shrider 2010). Because borrowers’ curtailment behavior is a good indicator of their excess capacity to cover debt (Lin and Yang 2005), they can mitigate the risk by absorbing a temporary increase in curtailments.…”

“…Alternatively, the view of voluntary deleveraging contends that mortgage curtailment is a voluntary action that is motivated by borrowers’ desire to reduce their outstanding debt (McCollum, Lee and Pace 2015). If the possibility of households borrowing funds from other sources to curtail mortgages is excluded, curtailments are essentially determined by household disposable income (Adelman, Cross and Shrider 2010). An increase in interest rates increases monthly mortgage payments and negatively affects curtailments.…”