Mortgage Amortization and Amplification

Chiara Forlati () and Luisa Lambertini

Working Papers from Center for Fiscal Policy, Swiss Federal Institute of Technology Lausanne

Abstract: Mortgages characterized by negative or low early amortization schedules amplify the macroeconomic effects of a housing risk shock. We analyze the role of mortgage amortization in a two-sector DSGE model with housing risk and endogenous default. Mortgage loan contracts extend to two periods and have adjustable rates. The fraction of principal to be repaid in the first period can vary. As the fraction of principal to be paid in the first period falls, steady-state mortgages and leverage increase and the impact of a housing risk shock on consumption and output is amplified. Borrowers prefer negative amortization. If free to choose the amortization schedule, borrowers would repay most of the principal in the last period of the contract. Low early repayments of principal allow borrowers to hold on to their housing stock and postpone default to the second period having incurred small sunk costs.

Keywords: Housing; Mortgage default; Mortgage risk (search for similar items in EconPapers)
JEL-codes: E32 E44 G01 R31 (search for similar items in EconPapers)
Pages: 45 pages
Date: 2012-02, Revised 2012-02
New Economics Papers: this item is included in nep-dge, nep-mac and nep-ure
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:cif:wpaper:201201

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