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- W1717369008 abstract "The boom in the subprime mortgage market yielded many loans with high LTV ratios. From a large proprietary database on subprime mortgages, we find that choice of mortgage rate type is not linear in loan sizes. A fixed rate mortgage contract is a popular choice when loan size, measured by LTV ratio, is small. As LTV ratio increases, borrowers become more likely to choose adjustable rate mortgage contracts. However, when LTV reaches a certain level, borrowers start to switch back to fixed rate contracts. For these high LTV loans, fixed rate mortgages dominate borrowers' choices. We present a very simple model that explains this 'nonlinear' pattern in mortgage instrument choice. The model shows that the choice of mortgage rate type depends on two opposing effects: a 'term structure' effect and an 'interest rate volatility' effect. When the loan size is small, the term structure effect dominates: rising LTV ratios making ARM loans less costly, and more attractive. However, when the loan size is large enough, the interest volatility effect dominates: rising LTV ratios making FRM loans less costly and preferable. We present strong empirical evidence in support of the model predictions." @default.
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- W1717369008 date "2010-01-01" @default.
- W1717369008 modified "2023-09-25" @default.
- W1717369008 title "Mortgage Contract Choice in Subprime Mortgage Markets" @default.
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- W1717369008 doi "https://doi.org/10.17016/feds.2010.53" @default.
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