Economics of Mortgage Termination in India

Piyush Tiwari

ERES from European Real Estate Society (ERES)

Abstract: Mortgage termination due to prepayment or default is an important issue in pricing of mortgage and mortgage-backed securities (MBS) due to its stochastic nature. In developing countries where MBS is not yet fully developed, mortgage termination affects the flow of funds to the lenders. Recent literature has used option price models (OPM) to analyze mortgage terminantion. Prepayment is a ëcall optioní whose price is dependent on fluctuation in market interest rates. Default is a 'put option' whose price is dependent on house price and interest rate. However, the termination of mortgage in housing is not as `ruthlessí as OPM theory would suggest, primarily because households are not financiers in `stricter senseí. Recent literature has used Cox proportional hazard model to model mortgage termination. The idea is that other household related variables besides option price of the instrument jointly determine the mortgage termination. We use Cox proportional hazard model to analyze termination of mortgage in India. The results indicate that financial concerns (like option price, loan to value ratio, house price and monthly principal and interest to income ratio) are important determinants besides household characteristics. Self employed or low educated or single borrowers have less probability of prepaying the loan. An important variable inducing prepayment is irregular repayment behaviour of borrower. If loan repayment is in arrears for some months, borrowersí often terminate their liability by prepaying.

JEL-codes: R3 (search for similar items in EconPapers)
Date: 2001-06-01
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