Do Mortgage Points Signal Mobility of Transaction Costs? Evidence from Securitization
Brent W. Ambrose
Pennsylvania State University
California State University at Fullerton
46th Annual AREUEA Conference Paper
To realize the benefit of the prepayment option embedded in a fixed-rate mortgage (FRM) contract, a borrower would have to make correct refinancing decisions. Hence, a FRM is never “maintenance-free”, such maintenance usually cost a substantial amount of time and effort. This paper asks the question: How do such costs influence borrower’s choice on mortgage points? We show that there exists a separating equilibrium such that borrowers with high costs pay more points to obtain a lower interest rate, and borrowers with low costs pay fewer points and receive a higher interest rate. In contrast, conventional mobility-based theory suggests that borrowers use discount points to signal mobility. It is unclear how lenders interpret the potential mixed screening role discount points. To separate the effect of transaction costs from that of mobility, we construct a transaction costs measure based on the “overvaluedness” of a loan. We find that overvalued loans and the ones with greater discount points are both more likely to be retained in the originator’s portfolio. This result suggests that securitization decisions are more likely made based on transaction costs rather than the expectations of mobility.
JEL Classification: L1working papers series
Date posted: November 30, 2010
© 2014 Social Science Electronic Publishing, Inc. All Rights Reserved.
This page was processed by apollo4 in 0.313 seconds