Perspectives on the maturity of mortgage debt

The maturity of mortgage debt, as a contractual feature and a household choice, has played a variety of roles in the mortgage economics literature. For example, the analysis of mortgage credit rationing by Kent (1980) focuses upon maturity as an element of the mortgage contract that can be varied to clear the mortgage market when it is in temporary disequilibrium. Moreover, the maturity of debt can be used as an indicator of mortgage credit rationing. This view should be qualified to the extent that choice of maturity reflects cost minimisation behaviour. It is also possible that choice of maturity can signal a borrower's credit risk characteristics (Harrison et al. 2004, Ben-Shahar & Feldman 2003). That is, if shorter maturities carry lower risk premiums then more creditworthy borrowers may choose shorter-term contracts.

The effects on the probability of default of increasing maturity are ambiguous (Ben-Shahar & Feldman 2003). Long maturities lower the risk of a liquidity squeeze via lower periodic payments, but also increase the number of periods over which a problem can arise. The net effect will depend upon actual contract terms and arguments such as the variance of the borrower's income and the variance of house prices. Interestingly, the balloon payment with its zero amortisation also increases the risk of default at the point at which repayment is required (see Noordewier et al. 2001). Thus both the choice or contractual restriction of maturity has relevance to mortgage/housing demand, default probabilities and the signalling of credit worthiness.

It is also worth noting that changes in maturity are one reaction, or strategy, for borrowers to avoid impending default, as well as a means of lowering its risk. Lenders will also prefer this as otherwise there are time and costs associated with default imposed on the lender (Harding & Sirmans 2002). There is now a literature on the renegotiation of debt to ease problems facing borrowers involving the choice between discounting the principle sum owed, or renegotiation of the term (Riddiough & Wyatt 1994; Anderson & Sundaresan 1996; Mella-Barral & Perraudin 1997). Though most of this work is applied to the commercial mortgage market it is clearly applicable to residential mortgages.

In the US maturity renegotiation is the more common form of dealing with 'troubled debt' than discounting the outstanding principal (Harding & Sirmans 2002). The preference for this strategy has been explained in terms of the fewer agency problems facing lenders. For example, borrowers for whom discounting of debt is a possibility may be tempted to divert cash flows from a property or take on more risk (Harding & Sirmans 2002). Residential borrowers facing risks of default may not maintain the value of the collateral for the loan by carrying out repairs and maintenance. Harding and Sirmans note the existence of a 'mortgage externality' where the limitation of the liability of the owner occupier to mortgage debt reduces maintenance and investment in property. This would not be less true of the UK where the mortgage liability remains after default.

So the maturity of mortgage debt is a complex variable to interpret and supplies yet another potential source of endogeneity and selectivity in mortgage demand equations. It can signal default risk, reflect the management of financial distress, be a means of minimising the impact of payment tilting or correspond with desired rates of amortisation. Given the likely endogeneity of choice of maturity in mortgage demand equations then reduced form equations in past research may have proxied this choice by the choice of mortgage instrument, personal characteristics, income, etc. The choice of mortgage maturity is an area that deserves more attention in empirical research. The empirical literature has largely focused upon the choice of debt maturity and its relation to amortisation.

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