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A Simple Model of Mortgage Insurance
Author(s) -
Brueckner Jan K.
Publication year - 1985
Publication title -
real estate economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.064
H-Index - 61
eISSN - 1540-6229
pISSN - 1080-8620
DOI - 10.1111/1540-6229.00345
Subject(s) - mortgage insurance , mortgage underwriting , payment , equity (law) , shared appreciation mortgage , economics , actuarial science , consumption (sociology) , home equity , insurance policy , floating interest rate , interest rate , business , monetary economics , finance , general insurance , social science , sociology , political science , law
This paper uses a two‐period model to analyze the borrower's choice of an optimal time pattern of mortgage payments in a world where future house values are uncertain. Since a decline in values can make the borrower's equity negative, leading to default on the mortgage, lenders in the model will require the purchase of mortgage insurance. The premium on the insurance policy will depend on the riskiness of the mortgage, which in turn depends on the magnitude of the initial mortgage payment. Mortgages with large (small) first payments will carry low (high) insurance premiums. Taking this fact into account, the borrower decides on the optimal riskiness of his mortgage. Borrowers who discount the future heavily choose risky mortgages carrying high insurance premiums, while those who place a higher value on future consumption opt for less risky contracts carrying low (or zero) premiums.