Working Paper: NBER ID: w27676
Authors: John Y. Campbell; Nuno Clara; Joo F. Cocco
Abstract: We study mortgage design features aimed at stabilizing the macroeconomy. We model overlapping generations of mortgage borrowers and an infinitely lived risk-averse representative mortgage lender. Mortgages are priced using an equilibrium pricing kernel derived from the lender's endogenous consumption. We consider an adjustable-rate mortgage (ARM) with an option that during recessions allows borrowers to pay only interest on their loan and extend its maturity. We find that this maturity extension option stabilizes consumption growth over the business cycle, shifts defaults to expansions, and is welfare enhancing. The cyclical properties of the maturity extension ARM are attractive to a risk-averse lender so the mortgage can be provided at a relatively low cost.
Keywords: mortgage design; macroeconomic stability; adjustable-rate mortgages; fixed-rate mortgages
JEL Codes: E32; E52; G21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| maturity extension option for adjustable-rate mortgages (ARMs) (G21) | stabilizes consumption growth over the business cycle (E20) |
| maturity extension option for adjustable-rate mortgages (ARMs) (G21) | lower mortgage default rate during recessions (G21) |
| maturity extension option for adjustable-rate mortgages (ARMs) (G21) | higher debt levels for those who utilize the option (G51) |
| higher debt levels for those who utilize the option (G51) | increase defaults during expansions (D25) |
| maturity extension option for adjustable-rate mortgages (ARMs) is welfare-enhancing (D69) | both borrowers and lenders benefit from its implementation (G21) |