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Exploring Alternative Mortgage Instruments for Inflationary Environments

Learn about various alternative mortgage instruments such as ARM, GPM, PLAM, RAM and their benefits in inflationary settings. Understand interest rate risks and how these instruments offer solutions to fixed-rate mortgages.

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Exploring Alternative Mortgage Instruments for Inflationary Environments

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  1. Chapter 9 Alternative Mortgage Instruments

  2. 9-1 Learning Objectives • List the basic characteristics of several types of alternatives mortgage instruments • Define standard mortgage elements such as interest rate, payment, discount points, and term • Describe how characteristics of various alternative mortgage instruments solve the problems of a fixed-rate mortgage in an inflationary environment

  3. 9-2 Interest Rate Risk • Thrifts have traditionally financed long-term assets (mortgages) with short-term liabilities (deposits) • When inflation increases interest rates, mortgage prepayments slow and rates on deposits increase • Rising interest rates create affordability problems

  4. 9-3 Adjustable-Rate Mortgage (ARM) • Frequency of Rate change • Index • Margin • Interest Rate Caps • Teaser Rate • Convertibility

  5. 9-4 Graduated Payment Mortgage (GPM) • Expectations of future inflation and the tilt effect • Payments on this fixed-rate loan are lower at the beginning of the loan and higher at the end • Negative Amortization • Borrowers can qualify for a larger loan and housing becomes more affordable

  6. 9-5 Price-Level Adjusted Mortgage (PLAM) • Contract rate is the real rate of return • Mortgage balance is adjusted by the inflation rate after the inflation has occurred • Upward adjustments create negative amortization • If inflation is not neutral, mortgage payments may increase at a faster rate than borrower’s income • Mortgage balance may increase at a faster rate than the value of the property • PLAMs may be used in conjunction with price-level adjusted deposits(PLADs)

  7. 9-6 Reverse Annuity Mortgage (RAM) • Typical mortgage is “ rising equity, falling debt” • RAM is “ falling equity, rising debt” • Borrower receives a series of payments and repays in a lump sum at some future time

  8. 9-7 Other Mortgage Types • Home Equity Loan • Biweekly Mortgage • Fifteen-year versus Thirty-year loans

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