Review Articles: Mortgage Termination Risk: A Review of the Recent Literature

By LaCour-Little, Michael | Journal of Real Estate Literature, September 1, 2008 | Go to article overview

Review Articles: Mortgage Termination Risk: A Review of the Recent Literature


LaCour-Little, Michael, Journal of Real Estate Literature


Abstract

This paper presents a review and synthesis of the past fifteen years of research on mortgage termination risk. Understanding termination risk is fundamental to explaining the workings of the now $13 trillion mortgage market. The review covers theoretical, empirical, and methodological work, including both residential and commercial market segments. In addition to synthesizing existing findings, open questions for further research are identified. The overall objective is to introduce this important topic to journal readers who may not be actively involved in the mortgage field and to stimulate thinking about open issues that deserve additional research.

Mortgage loans are among the most complex of financial contracts due to the uncertainty of their duration. This uncertainty arises because they may terminate early as a result of either default or prepayment. Default occurs when the borrower cannot, or will not, make contractually promised payments. Prepayment occurs when the loan is paid in full prior to maturity. Causes for these two outcomes are varied, adding to the complexity of explaining and, ultimately predicting, the rate of termination for the loans that are either held in portfolio by financial intermediaries or which provide backing by mortgage-backed securities (MBS). While textbook treatments of this topic (e.g., Clauretie and Sirmans, 1998) typically introduce readers to related industry jargon and provide a few examples of how early termination rates can affect values of mortgage-related assets, the underlying research on termination risk is mentioned only briefly.

To provide a sense of the variation in recent termination rates, consider the following stylized facts on residential mortgages as of December 2006.' While the overall rate of serious delinquency2 for prime single-family mortgages was 0.7%, there was considerable geographic variation, ranging from 0.3% in California to 2.3% in Louisiana. In the subprime segment of the market, the national rate of serious delinquency was 7.8% but as high as 14% in Louisiana and Mississippi; both states recently affected by extensive hurricane damage, of course. In terms of prepayment, prime loans showed a 15.7% rate nationally and subprime loans a 33% rate,3 much higher than would result from household mobility alone.4 For comparison, as of fourth quarter of 2006, the delinquency rate for commercial mortgages on bank balance sheets was 1.3% (Federal Reserve, 2006)5 and the delinquency rate on commercial mortgage-backed securities was at an all-time low of 0.27% (Standard and Poor's, 2007).

What economic factors produce these results and how do they vary across loan types and over time? Couching the question in an option-theoretic framework, what factors affect exercise of these options and how may those processes best be modeled? 1 review relevant research, identify major themes, and attempt a synthesis: What do we know and what do we not know? In the process, I will also identify open questions and industry trends likely to produce new answers, and probably new questions, in the future.

I focus on the literature from 1992 to 2007 for several reasons. First, the journal published a previous review (Dickinson and Heuson, 1994), which surveys the early research up to 1992, though limited in focus to prepayments in the residential mortgage market. Second, two frequently cited reviews of default risk were published at about this same time (Quercia and Stegman, 1992; and Vandell, 1993). Finally, the period 1992-2007 has been a particularly dynamic period, with the development of commercial mortgage-backed securities, creation and growth of the subprime residential segment, wide adoption of automated underwriting, and generally low interest rates and robust property values, at least up until the housing market downturn in late 2006.

Why should we be interested in mortgage termination rates? The main objective has been to explain the pricing of mortgages and mortgage-related assets. …

The rest of this article is only available to active members of Questia

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Default project is now your active project.
Project items

Items saved from this article

This article has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this article

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Buy instant access to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited article

Review Articles: Mortgage Termination Risk: A Review of the Recent Literature
Settings

Settings

Typeface
Text size Smaller Larger Reset View mode
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Help
Full screen

matching results for page

    Questia reader help

    How to highlight and cite specific passages

    1. Click or tap the first word you want to select.
    2. Click or tap the last word you want to select, and you’ll see everything in between get selected.
    3. You’ll then get a menu of options like creating a highlight or a citation from that passage of text.

    OK, got it!

    Cited passage

    Style
    Citations are available only to our active members.
    Buy instant access to cite pages or passages in MLA, APA and Chicago citation styles.

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

    1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

    Cited passage

    Thanks for trying Questia!

    Please continue trying out our research tools, but please note, full functionality is available only to our active members.

    Your work will be lost once you leave this Web page.

    Buy instant access to save your work.

    Already a member? Log in now.

    Oops!

    An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.