Fixed Rate Endowment Mortgage and Mortgage Indemnity Valuation

Jose A. Azevedo-Pereira, David Newton, Dean A. Paxson

Research output: Contribution to journalArticle

17 Citations (Scopus)

Abstract

We use a contingent claims framework for valuing the the default and prepayment embedded options in certain British fixed-rate endowment mortgages, with a (capped) mortgage indemnity guarantee (MIG). This methodology provides a template for the borrower, lender, and insurer to compare mortgage terms, including the fairness of contract rates, arrangement fees, prepayment penalties, any MIG premiums required, and co-insurance exposure. With empirical inputs, this model may eventually be useful as a “mark-to-value” proxy for all parties, as expected parameters change (especially interest rate and house price levels, and expected future volatilities), for purposes of determining “valued added accounting”, appropriate reserves, and indeed for setting premiums and business drivers. Fixed-rate endowment mortgages differ from fixed-rate repayment mortgages primarily because, in the event of early termination, the amount owed by the borrower is a function of the evolution of the term structure of interest rates, whereas for a repayment mortgage it is pre-determined. We compare endownment and repayment mortgages for different levels of loan-to-value ratios, interest rate and house price volatilities.
Original languageEnglish
Pages (from-to)197- 221
Number of pages25
JournalJournal of Real Estate Finance and Economics
Volume26
Issue number2-3
DOIs
Publication statusPublished - 1 Mar 2003

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