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Nontraditional Mortgage Products: Innovative or Toxic?

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Consumer Knowledge and Financial Decisions

Part of the book series: International Series on Consumer Science ((ISCS))

Abstract

Do nontraditional mortgage products somehow coerce borrowers to overextend themselves and increase foreclosure risk? Conversely, do traditional mortgage products restrain borrowers and safeguard them against default? While nontraditional mortgage products often allow borrowers to share more interest rate risk with the lender, these products were not inherently designed to put borrowers into financial stress. Default is often related to trigger events and negligent underwriting, and when these factors are absent, nontraditional mortgage products may result in greater short- and long-term liquidity for borrowers. After a review of various nontraditional mortgage products, an analysis follows, which uses data from the Survey of Consumer Finances to examine the extent delinquency problems should be attributed to the type of mortgage product that borrowers select or to unexpected negative changes in their circumstances.

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Notes

  1. 1.

     Economists do not have a consensus definition for subprime lending. For more information on the specific definitions of subprime, see Sengupta and Emmons (2007).

  2. 2.

     For academic research on borrowing constraints due to having insufficient income or wealth, which may translate into a down payment hurdle for borrowers, see Stiglitz and Weiss (1981), Linneman and Wachter (1989), Zorn (1989), Haurin, Hendershott, and Wachter (1997), Rosenthal (2002), and Quercia, McCarthy, and Wachter (2003).

  3. 3.

     Collateral-dependent lending is the practice of underwriting loans based upon underlying home values as opposed to the ability of borrowers to repay using their own resources. On July 14, 2008, the Federal Reserve Board issued a rule prohibiting collateral-dependent lending. See http://www.federalreserve.gov/newsevents/press/bcreg/20080714a.htm.

  4. 4.

     The lender may suspend the fourth payment option over periods when house prices are falling.

  5. 5.

     The foreclosure trends discussed here refer to data releases from the National Delinquency Survey conducted by the Mortgage Bankers Association. More information can be found at http://www.mbaa.org/ResearchandForecasts/ProductsandSurveys/NationalDelinquencySurvey.htm.

  6. 6.

     A risk-averse borrower would be expected to prefer a FRM (see Campbell & Cocco, 2003).

  7. 7.

     There are no SCF questions that would indicate whether borrowers understood that longer term rates incorporate inflation expectations, while shorter term rates reflect more immediate financial market liquidity needs, or whether they understood that ARM payments are tied to shorter term rates.

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Acknowledgments

I thank James R. Follain, Mark P. Keightley, Farris G. Shuggi, and anonymous referees for helpful comments. All views expressed herein are my own and do not reflect any positions of the Congressional Research Service. All remaining errors are my own.

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  1. Library of Congress, Congressional Research Service, 101 Independence Avenue, SE, Washington, DC, 20540, USA

    Darryl E. Getter

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  1. Darryl E. Getter
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Correspondence to Darryl E. Getter .

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  1. Dept. Economics, University of Maryland, Baltimore County, Hilltop Circle 1000, Baltimore, 21250, Maryland, USA

    Douglas J. Lamdin

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Getter, D.E. (2011). Nontraditional Mortgage Products: Innovative or Toxic?. In: Lamdin, D. (eds) Consumer Knowledge and Financial Decisions. International Series on Consumer Science. Springer, New York, NY. https://doi.org/10.1007/978-1-4614-0475-0_12

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