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The Effects of Non-Recourse Mortgages on Default Risks and Households' Surplus

Keeyoung Rhee

KDI Journal of Economic Policy, 2018, vol. 40, issue 3, 69-89

Abstract: We study whether a default option attached to non-recourse mortgages improves borrowers' surplus from mortgage financing. By defaulting on mortgage debt, borrowers can save their non-collateralized income from being foreclosed. In exchange, borrowers must forgo non-monetary surplus from retaining any collateral. Banks may charge a high mortgage rate due to increased default rates. We find that the interest rate of non-recourse mortgage decreases with the borrower's surplus from home ownership. Moreover, non-recourse mortgages benefit only borrowers who deem housing property as an investment asset. Hence, the transition to a non-recourse mortgage is detrimental to welfare if the borrower enjoys a large surplus from home ownership. Although the borrower privately knows how much surplus she enjoys from home ownership, a menu of non-recourse mortgage contracts may exist, yielding a separating equilibrium without information rent.

Keywords: Non-recourse Mortgage; Strategic Default; Adverse Selection (search for similar items in EconPapers)
JEL-codes: D82 G18 G21 (search for similar items in EconPapers)
Date: 2018
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