Embedded Options in the Mortgage Contract

Brent Ambrose and Richard Buttimer

Zell/Lurie Center Working Papers from Wharton School Samuel Zell and Robert Lurie Real Estate Center, University of Pennsylvania

Abstract: This paper introduces a more detailed specification of the default process on single family residential mortgages: the borrower’s ability to reinstate the mortgage out of default prior to foreclosure. Inclusion of this detail allows for a more thorough analysis of lender loss mitigation programs. We find: Loan forebearance programs which provide borrowers additional time in default lead to higher delinquency rates; however, there is a corresponding increase in the odds of borrower reinstatement. In areas with stable house prices, optimal loss mitigation programs provide provide an economic incentive for the borrower to cure in conjunction with seeking deficiency judgments. Waiving default penalties is not effective in reducing default costs. Borrower assumptions concerning credit reputation significantly impact default and foreclosure. Lenders need to reinforce the impression that default will negatively impact future credit opportunities.

Date: 1998-07-03
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Journal Article: Embedded Options in the Mortgage Contract (2000)
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