Improving Risk Sharing and Borrower Incentives in Mortgage Design

37 Pages Posted: 18 Sep 2015 Last revised: 4 Apr 2017

See all articles by Yuchen Mei

Yuchen Mei

University of Waterloo - Department of Statistics and Actuarial Science

Phelim P. Boyle

Wilfrid Laurier University - School of Business & Economics; University of Waterloo

Johnny Siu‐Hang Li

University of Waterloo

Date Written: September 4, 2015

Abstract

In a traditional fixed rate mortgage, the borrower pays a fixed amount each period regardless of the value of the mortgaged property. One problem with this contract is that the borrower is less willing to pay when the house value falls. This was clearly seen in the 2008 financial crisis and its aftermath when mortgage default rates and foreclosures skyrocketed as the housing market crashed. A more efficient contract design should link payments to house prices so that the borrower's incentive to pay is not undermined by a decline in property value. In addition this design can save the lender the deadweight foreclosure costs. In this paper we examine two proposed index linked mortgages which have this risk sharing feature. We analyze the effect of both designs on borrower incentives in a multi-period setting.

Keywords: Borrower incentives, Mortgage default risk, Property index-linked mortgages, Risk sharing

Suggested Citation

Mei, Yuchen and Boyle, Phelim P. and Li, Johnny Siu‐Hang, Improving Risk Sharing and Borrower Incentives in Mortgage Design (September 4, 2015). Available at SSRN: https://ssrn.com/abstract=2661852 or http://dx.doi.org/10.2139/ssrn.2661852

Yuchen Mei (Contact Author)

University of Waterloo - Department of Statistics and Actuarial Science ( email )

Waterloo, Ontario N2L 3G1
Canada

Phelim P. Boyle

Wilfrid Laurier University - School of Business & Economics ( email )

Waterloo, Ontario N2L 3C5
Canada
519 884 1970 (Phone)
519 888 1015 (Fax)

University of Waterloo

Waterloo, Ontario N2L 3G1
Canada

Johnny Siu‐Hang Li

University of Waterloo ( email )

Waterloo, Ontario N2L 3G1
Canada

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