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Economic-Efficient Mortgages

Importance of Economic-efficient Mortgages

Mortgages are central to the housing sector, especially based on how they are intrinsically tied to the economy (Nubi 2010). Millions of people across the world are only able to own homes through mortgages, which are long-term loans that are specially geared towards housing financing (Calza, Monacelli, & Stracca 2013). The implications of mortgages to the economy are profound as evident in the fact that the housing industry accounts for 10% of the US economy (Kung 2012). In this case, it is imperative to have economic-efficient mortgages to ensure benefits to the economy and the general population.

Discussion on Economic-efficient Mortgages

Shared Appreciation Mortgages (SAM)

Shared Appreciation Mortgage (SAM) refers to a mortgage plan where a lender offers an interest-free or a lower interest loan facility than the prevailing market interest rates for mortgages in exchange for a share of the appreciated value of the property. Shared Appreciating Mortgage can be viewed as a participating mortgage loan where the borrower is allowed to pay an amount that is below the market interest while the lender receives an ownership share in the property (Sharma 2010). The share of the appreciated value of the property is referred to as the contingent interest. This fee is paid at the termination of the contract once the property is sold. The use of the Shared Appreciation Mortgages (SAM) is not widespread. SAMs are majorly used in times when the prevailing nominal interest is high to the extent of limiting many borrowers who are not able to afford mortgages under the traditional mortgage payments (Shiller 2014; Kling 1982). Due to its affordability and ease of conditions, the Shared Appreciation Mortgage is highly preferable by poor borrowers or first-time homeowners who cannot afford the expensive and high-interest traditional mortgage loans (Bernanke 2008). In this way, this group of people can realize their dreams of owning a home. On the other hand, a Shared Appreciation Mortgage offers the lenders the advantage of cushioning them from capital erosion through inflation that is present in the traditional mortgage plans such as the fixed interest rate mortgage (Yellen 2009; Aalbers 2008). In the permanent interest rate credit, the lender offers the loan at an unchanging interest rate. The implication is that the final amount that will be paid at the end of the repayment period is known from the start (Ferguson & Smets 2010). However, during this period, if price increment occurs, the value of the total amount that will be paid will be less compared to the situation where inflation does not occur (Kung 2012). However, through SAM, any inflation will be catered for since the repayment is a share (mostly a percentage) of the appreciated value. In most cases, the share of the appreciated value is pegged between 50% and 75% (Shiller 2014).

In the history of the housing sector, major price long upswings and downswings in house prices have significantly affected housing affordability and access to financial services by potential house owners (Campbell 2013). Indeed, during the key house price upswings, policymakers have recognized how such issues limit or reduce house affordability. As such, such periods are characterized by new policies since policymakers find new ways of increasing affordability and reducing loan defaults (Boleat 2012). The Adjustable-Rate Mortgage (ARM) is one of these innovations, which offered borrowers a low rate interest rate at the beginning of the mortgage, but which would be adjusted in later years of the loan. However, in this case, in the event that the houses prices stop rising, the homeowners are stuck with loans that they cannot refinance once the initial low-interest-rate period is over (Agarwal, Driscoll, & Laibson 2013). As compared to ARMs, SAMs offer a straightforward advantage where they allow a reduction of financial costs without upswings in the future that occurs, no matter the value of the house. According to Blackburn and Vermilyea (2012), SAMs offer the lender the best security against a fall in house value. Since SAMs are offered at a reduced interest rate in addition to the share of the appreciation value, any upswings or downswings would be of little value since the lender can easily renegotiate to wait until the house returns to positive equity for appreciation value to be acquired (Kau, Keenan, & Li 2011).

The advantages of SAMs are evident. However, one of the major hindrances towards realizing their effectiveness and full implementation in the financial sector is the regulatory hurdles (Lang & Jagtiani 2010; Avery et al. 1996). For instance, in the United States, the upgrading of SAMs is hindered by the no-ruling list where the treasure places SAMs on the no-ruling list, thus making it impossible to get advance rulings concerning ownership implications and tax status of borrowers and lenders under the SAMs arrangement (Lovell & Smith 2010). Further, the uniquely punitive treatment of SAMs where investors are taxed prior to being paid off is a chief obstruction towards their upgrading not only in the US but also in many developed world financial sectors.

From the above discussion, it is evident that SAMs have many advantages, especially in ensuring that individuals who have low-income thresholds can afford house financing. However, some problems are associated with the loan facility (Hamel & Prahalad 2013). Firstly, Ganapati (2010) presents the issue of excessive borrowing cost whereby in the event of rapid house price appreciation, the cost of borrowing increases rapidly to excess levels, which can make it difficult for borrowers to pay the principal amount. In this case, it is crucial to have regulatory frameworks that limit the amount of appreciation sharing.

The second key problem arises from moral hazard where an assumption is made that the owner of the house or the borrower will take care of the house from tear and wear. Consequently, he or she should preserve its value to ensure that the lender will get the value for the money once the loan matures (Hamel & Prahalad 2013; Kiyotaki, Michaelides, & Nikolov 2011). In this case, the owner of the house is under the moral obligation to maintain the house while under his or her ownership, yet it is not through coercion. In this case, if the owner does not maintain the property such that it loses value within the loan duration, the lender is likely to incur losses. The asset owner may not gain as much as he or she would have acquired if the property had maintained or increased its value through appreciation. The other major problem is that SAMs are linked to price distortion where valuation at the point of origination and at resale may unnecessarily increase the amount of shared appreciation worth that the homeowners are likely to pay (Archer & Smith 2013; Ebrahim & Hussain 2005).

Continuous Workout Mortgages (CWM)

Continuous Workout Mortgages refer to a loan facility for housing where the principal or the periodical payment is adjusted according to changes in house prices in the market. In other words, CWMs offer an alternative to the traditional inflexible mortgage facilities such as the Fixed Rate Mortgages, Adjustable Rate Mortgages, and their related mortgage plans, which are rigid and often very expensive due to their lack of consideration of market and economic forces that may significantly affect the homeowners’ ability to repay their loans (Cherry, Hanratty, & Advisors 2010). In this case, by offering a mortgage loan facility, which can be adjusted according to the changes in the economy, both the lender and the borrower are cushioned from market shocks that can have adverse effects not only on the lender and borrower but also on the wider economy of the nation (Mah-hui 2008). Through the CWM, periodical disbursements and credit balances are updated involuntarily with the shifting home rates (Shiller 2014; Bostic et al. 2012). One of the most significant aspects of the CWMs is its consideration of the changing income of the borrowers due to economic changes, which can greatly influence their ability to make monthly repayments without defaulting (Bredenoord & van Lindert 2010; Varli & Yildirim 2014). Consequently, by adjusting according to these considerations, the lender is assured of monthly repayments, which consequently lead to minimal defaults and hence a primary reprieve to the borrower (Das & Meadows 2013). With the adjustments that are made according to the economic changes, the aim of CWMs is to keep the balance of the mortgage below or equal to the value of the property to reduce the default risk (Temkin, Theodos, & Price 2011). Through the Continuous Workout Mortgage, both the lender and the borrower share the risk as a way of ensuring that no one is disadvantaged (Kau, Keenan, & Li 2011). For instance, if the property appreciates during good economic times such as during low-interest-rate periods, the borrower can participate as a strategy to reduce the prepayment risk. On the other hand, the homeowners face a moral obligation to ensure that they are interested in repaying the loan. If this plan is not the case, the lender experiences a moral hazard (Scanlon, Lunde, & Whitehead 2011; Gramlich 2007). For example, individuals may deliberately lose a job to bring the interest rates down. On the other hand, although the individuals may be working, they can choose not to report any income. In this situation, lenders may find themselves in a difficult situation where loans are paid over a prolonged period or are being declared as defaulted, and hence a loss to the lender. However, the knowledge of CWM is still growing.

As compared to Shared Appreciation Mortgages, CWMs provide a better arrangement for the lender since issues such as moral hazards on the part of the borrower are eliminated (Cox, Brounen, & Neuteboom 2011). However, while the lender and borrowers are cushioned from inflation through the adjustable repayments as inflation changes, the lenders may not be protected against the depreciation of the home value against which the monthly principal is set (Wilkinson‐Ryan 2011). Therefore, it is imperative to put measures such as a limiting threshold below which the home value cannot go, and hence ensuring that only changes in the prevailing market home prices are considered, as opposed to the actual value of the home by factoring in depreciation. Another advantage of CWMs as compared to other mortgage facilities such as the Price-Level Adjusted Mortgages (PLAMs), which will be discussed later in the paper, is that CWMs are pegged on house prices in the local market (Fabozzi, Bhattacharya, & Berliner 2010). In this case, instead of using inflation rates that are calculated through broad indices such as the consumer price index, the use of local house prices ensures that individual’s loans are calculated factoring in local specific market dynamics. Such dynamics may affect the affordability and access to mortgages, as well as make it difficult for borrowers to repay their loans (Shiller et al. 2015).

Price-Level Adjusted Mortgages (PLAMs)

The Price-Level Adjusted Mortgage (PLAM) refers to a finance advance, which is based on an unchanging interest but a modifiable principal balance amount. The adjustment of the principal balance is based on the inflation rate at the time. According to Ding et al. (2011), PLAMs have payments that are constant in real terms whereby the payments increase in proportion to the price level, as opposed to being constant as witnessed in the case of the conventional fixed-rate mortgage (FRM). In the conventional debt, the tilt problem where the interest rate remains constant has been accused of the current housing affordability challenges since it does not consider the real terms, which are dictated by the changes in the economy (Mullins & Pawson 2010). On the other hand, the payments in PLAMs retain their real purchasing power (Shiller et al. 2013). In PLAMs, the borrower receives a lower rate compared to the market interest charge. However, he or she has to agree on the principal amount adjustments to inflation throughout the entire life of the loan (Nguyen & Pontell 2010; Deng, Shen, & Wang 2011). While the borrower can access lower interest rates than the prevailing market charges, the lender can be cushioned from inflation’s erosion to ensure that the value of the home can be raised indirectly (Krainer & Laderman 2014). The prevailing inflation or deflation rates are calculated and incorporated into the remaining balance at the arranged period between the money giver and the debtor. However, in most cases, inflation or deflation is considered on a monthly basis. Through this process, the PLAMs is based on the conviction that real incomes and real values of houses are more predictable as compared to the use of nominal terms, which ensure that the PLAMs are safer for both lenders and borrowers (Shiller 2014). Further, the use of real terms ensures that lenders are exposed to less default risk as compared to the use of conventional debt approaches. The implication is that the borrowers pay a varying amount of interest to the lender each month during the life of the loan facility. However, since it is not possible to have constant economic conditions, inflation or deflation means that the monthly repayment amount is likely to rise or drop according to the adjustments during the life of the loan facility (Gerardi & Li 2010).

Participating Mortgage (PM)

The Participating Mortgage (PM) refers to a mortgage loan, which allows the lender to participate in the income that such properties bring whether through leasing or resale (Cherry, Hanratty, & Advisors 2010). For instance, if a lender offers a given amount of loan towards the purchase, building, or renovation of a given property, other than the agreed interest rate, which in most cases lower than the prevailing market rates, the lender is entitled to a share of the amount that is received from the sale of rental of the asset. The PMs offer a huge advantage to the lender and the borrower is different ways (Bostic et al. 2012). Firstly, the borrower can receive lower interest charges for the loan. The implication is that the periodical payments are lower and hence manageable compared to the case of a fixed-rate mortgage (Anikeeff & Muller 2012; Yiu 2007). On the other hand, by sharing the income stream with the lender, the borrower can gain from the financial experience and knowledge of the lender as a way of increasing the property’s ability to yield a profit (Piskorski & Tchistyi 2010; McCord et al. 2011). For the lender, the advantage of the arrangement is that other than receiving the interest rate only, the shared profits also contribute to increased earnings. The participation of the lender also reduces the risk of default since there is increased monitoring of the management of the property to ensure profitability (Allen & Carletti 2013). PMs are vital since they create a way for increased efficiency and reduced risk of default through the shared income that the property brings.

Despite the above simple explanation to PMs, they can be very complex and hence the reason why they are yet to be adopted widely. In this case, the main assumption concerning PMs is that the property in question will earn income as predicted by various considerations that are put in place by the borrower (Miles 2012). The key characteristic of PMs can be termed as the mortgage’s exchange for guaranteed returns. The returns are expected from uncertain future benefits from the property in question. While this case is the underlying conception of PMs, it is its primary risk factor (Gerardi & Li 2010). It is evident that in the last century, key upswings and downswings in the property industry mean that such instruments (benefits from uncertain future) may yield minimal returns, hence making the PMs risky as compared to CWMs or the PLAMs. However, according to Shiller et al. (2011), well-structured PMs can bring the desired benefits to the borrower and most importantly to the lender who takes the greater liability. In the process of structuring PMs to ensure that the lender gets the best value for money, the valuation of the participating mortgage requires a thorough analysis of the uncertain future events that may affect the income (Gerardi & Li 2010; Scanlon & Elsinga 2014). In this case, the lender must ensure accurate calculation and estimation of the net operating income (NOI), which must consider the subject’s (property) competitive position in the market. Such considerations must factor in the current and future income, expense, and occupancy levels, and the investor requirements on the rate of capitalization and long-term yields. Any changes that may occur in the assumptions made at the beginning of the loan facility may have significant impacts on the residual portion of the projected income stream and consequently affect the lender’s ability to recoup the expected earnings from the mortgage (Shiller et al. 2011). However, while the PMs are a key reprieve to a borrower since they allow low rates of repayments, the major hurdle is in the participation approach as far as how much income from the property’s proceedings will go to the borrower. In some instances, the ownership arrangement of the debt may mean that much of the income from the earnings from the property may go towards the repayments, thus leaving the borrower with little income, which may further go towards repaying the amount that is not covered through the participation arrangement.

Amortizing Participation Mortgages (APMs)

Amortizing Participation Mortgages (APMs) refer to a loan facility, which builds upon the Participation Mortgages but with the added feature of amortization, which helps to simplify the agency issues of mortgage loans (Gerardi & Li 2010). In this case, through APMs, the problem of the classic mortgage tilt where high inflation rates negatively affect affordability is solved (Lovell & Smith 2010). Consequently, APMs increase affordability while at the same time reducing the common agency costs of the debt. In this loan arrangement, amortization means that the loan will require the borrower to make payments on both the principal and the interest. In addition, as a participating mortgage, the lender will also be entitled to a share of the income proceedings from the property. According to Trevino and Nelson (2010), APM solves two main issues that affect the financial intermediation system as far as housing financing is concerned. The first advantage is that it reduces agency costs of debt, hence leading to increased affordability. Further, the above solutions lead to an increase in the demand for real estate (Ebrahim & Hussain 2010). They also reduce the fragility of the financial intermediation system, which is primarily based on interest-only loans (Kung 2012).

Other Approaches towards Economic Efficient Mortgages

While the above approaches to more efficient mortgages are valid and essential in guiding the future of the mortgage industry, other suggestions have been made to eliminate the current inefficiencies that are found in conventional debt. Firstly, one of the main lessons that have been learned from previous crises involving the housing sectors, which have exposed the inefficiencies of the conventional debt, is the lack of cash-in-hand for the borrowers to spend (Burns & Grebler 2012). In other words, many house owners who are at risk of default or who are struggling to pay their mortgages have liquidity problems, which emanate primarily from lost jobs, lower or zero) incomes, and a weaker economy, especially due to economic downturns. In this case, increasing cash flows can ensure consumption spills over to the local and national economies. A study by McDonald (2012) found that during income shocks, illiquid households experience the most drastic changes in spending behavior. Ensuring the liquidity of cash in households means that people will spend. This expenditure will mean more earnings for others. Such a cycle ensures less default since borrowers have a chance to continue their payments. According to Nicholson (2014), one of the main approaches through which cash flows in households can be increased is through restructuring of mortgages in response to economic changes that may affect the ability of people to repay their loans. In restructuring loans, the main approaches that are highly preferred include lowering the monthly payments through various plans such as lowering the interest rate for a given duration, a payment deferral, or even a mortgage term extension (Lewis et al. 2010). Such approaches mean that households will maintain some level of income liquidity to ensure that they can spend and hence reduce the urge to default on loans. The approach has better outcomes as compared to decreasing the loan’s value or the owed principal since this principal deduction often spreads the payments of the loan over its entire period (Arkcoll et al. 2013). However, the deduction does not lead to increased liquidity. The reason behind strategic default is that homeowners feel that they are paying higher for less value of their houses. Although they can pay, the plan does not make economic sense to them. According to Wagner, Shubair, and Michalos (2010), strategic default is a central problem, especially following major economic downturns after a period of upswing where older credit holders find themselves locked inexpensive mortgages as compared to what would be possible in the current period of the downswing.

Another key approach to addressing the problems faced by the conventional debt arrangement is the addressing of the issue of strategic default. In this case, strategic default refers to a planned evasion due to the individual’s inability to repay, especially when homeowners who have high-value mortgages as compared to the home value opt to walk away instead of continuing to pay (Sharma 2010). To address the problem of strategic default, one of the primary approaches is through the reduction of the loan’s value, which can be achieved by refinancing or writing down the principal to ensure that homeowners can pay rather than walking away (Burns & Grebler 2012). A write-down is more effective since it is appealing to homeowners who are willing to stay in their houses where they do not pay more than its current worth (Berkovec, Chang, & McManus 2012). On the other hand, it appeals to the lenders since it reduces the risk of default that leaves them with a house that has less value (Malackowski 2006; Cooke 2014). However, one of the central problems that arise from the strategic default is the fact that it is difficult to predict who will walk away from paying their mortgages through premeditated evasion. In this case, when this approach is compared to CWMs or PLAMs, the latter is effective and efficient in terms of eliminating strategic defaults (Lewis et al. 2010). To address the above challenge of the strategic default, the regulators should put in place policies that promote write-downs, especially during periods of significant economic downswings where the values of homes depreciate to reduce the risk of default on a larger scale.

Other approaches are also available in the industry. For instance, lease purchase is another approach, which involves an agreement where an individual is offered the option to rent a house (Burns & Grebler 2012). However, instead of the normal rental plans, the periodical rental payments go towards buying the house (Arkcoll et al. 2013). In other words, in the lease-purchase plan, the value of the house is determined. The required monthly payments are also determined over a given duration (Gerardi & Li 2010; Stephens 2007). Once the individual makes cumulative rental payments that equal to the value of the rental, the tenant assumes the ownership of the property.

A partnership agreement that involves joint ownership of units and sale thereafter is also a viable alternative towards the purchasing of houses (Berkovec, Chang, & McManus 2012). In this case, the loan facility is shared between two or more people as a way of drastically reducing the payment for each individual who services the loan (Shiller et al. 2015; Kothari 2006). It also allows larger projects to be undertaken to attract more profits and returns on their sale.

Non-bank financial institutions such as NGOs are increasingly joining the housing sector. However, the amount of loans that these organizations can offer is very limited (Arkcoll et al. 2013). The qualification for such loans is very difficult. In most cases, these non-bank institutions do not operate for profit. Hence, their loans are majorly interest-free or set at very low-interest rates (Shiller 2014). These loan facilities are primarily targeted to the poorest and disadvantaged people, including those who have faced disasters. Hence, they are not replicable on the wider population.

On the other hand, cooperative-shared ownership is a model of house ownership where a family purchases a share in a cooperative such as an apartment or other multi-family development (Berkovec, Chang, & McManus 2012). The family gains the right to occupy one unit, as well as the ability to vote on matters of common interest to the families or people in the cooperative (Wagner, Shubair, & Michalos 2010). One of the key characteristics of the cooperative is shared ownership and decision-making for the best interest of the group.

Literature on Efficient and Effective Methods of Mortgage and Home Financing

In the light of these challenges in the traditional housing financing approaches, efforts have been put towards efficient and economically responsive approaches that are aimed at reducing the fragility of the financial system (Lux & Sunega 2010). Further, these methods are aimed at reviving the economy and ensuring stability and resilience to any shocks in the economy and the housing sector (Immergluck 2011). However, while growing interest has been witnessed in these new approaches to housing financing, limited literature has shed light on their functionality and long-term implications for the economy (Schwartz 2012). However, while this case is a primary cushion against market forces such as inflation, limited literature is available to show how such a loan facility can be received in times of economic prosperity together with the increased household incomes (Ding et al. 2011). For instance, the use of caps to gauge how high or low the interest rates can go depending on the economic performance of the time has not been well considered. This factor may be a good aspect of consideration to ensure that interest rates do not skyrocket at the expense of the borrower or go very low at the expense of the lender.

Few studies have clearly identified the long-term implications of SAMs to the financial intermediary system (Saunders & Cornett 2012). For instance, a case study that was carried out in the UK and Scotland, which were the first countries to offer SAM, shows that many borrowers are locked in a major dilemma. The sale of their houses that they have acquired through SAM, which has appreciated up to 600%, may not benefit them or offer them the ability to afford other houses since their loan facilities are interest-free but pegged on 75% of the appreciated value (Shiller et al. 2015; Choguill 2007). Such revelations clearly show that while SAM loans offer individuals high levels of affordability, they may have negative consequences, especially in the event of high inflation, which may make it difficult for homeowners to purchase new houses once they sell their current ones to pay the agreed appreciated value.

The Participating Mortgages offer an essential advantage over interest-only mortgages since they allow borrowers to have ownership of their property even during times of crisis by lowering their interest (Shiller et al. 2015). The traditional approaches to financing housing use the plain vanilla debt that is highly inefficient since it is based on the lowest rate of the ‘Pareto-Efficiency’ (Gerardi & Li 2010). The main constraint that is evident in the plain vanilla debt is that they have rigid payments, which ensure that they have a high fragility to the financial intermediation system (Archer & Smith 2013). This vulnerability is evident across all the primary plain vanilla debts, which include the Fixed Rate Mortgage (FRM), Adjustable Rate Mortgage (ARM), or a hybrid of the two. To capture this key drawback of the plain vanilla debts, Shiller et al. (2011) say that the loans are expressed in conventional nominal terms, which involve a high and variable inflation rate that indicates a high degree of uncertainty about the future price levels (Ebrahim, Shackleton, & Wojakowski 2011). This situation can have adverse effects on the economy and financial markets and consequently lead to ‘spill over’ effects that result in inefficient allocation of savings and the stock of capital (Saunders & Cornett 2012).

Apart from the above literature that has majorly focused on suggesting new mortgage approaches, there is an increasing consensus that these new mortgages hold repercussions, which are not yet known and which would probably lead to unknown Pareto inefficient consequences. For instance, despite the much-hyped benefits of the SAMs, their impacts have only been realized recently when beneficiaries of such loans found themselves with properties whose value that had appreciated by 600% was insignificant since the shared appreciation worth was set at 75%. In response to the unknown consequences of the proposed new mortgage approaches, which can only be realized once the mortgages have been implemented in the market, some individuals have brought their views on the issue. They say that it is better to review and restructure the existing conventional debt approaches in light of the lessons that have been learned since such approaches have been in the market for a long. As previously discussed, such measures include addressing strategic default through refinancing or restructuring loans to ensure that homeowners only pay an amount that is equivalent to their current home values, as opposed to walking away. Secondly, through the increased liquidity of households, more money may circulate in the local and national economies. This situation may effectively lead to higher payment records. To increase liquidity, policymakers should opt for restricting loan facilities to be cut down via lower interest rates or extending the repayment durations. The strategy can result in more liquidity at the household level and the economy, thus leading to fewer defaults.

Detailed Discussion on Continuous Workout Mortgages (CWMs)

2007/2008 economic downtown exposed major weaknesses in the existing housing financing approaches. Consequently, the situation called for “opening anew” to map the way forward on the future of the housing and the financial sector. The weaknesses of the plain vanilla debt facilities were exposed as evident in their significant impact on the economy, the financial intermediation sector, as well as on individual incomes (Gerardi & Li 2010). One of the fears that are currently being faced in the financial intermediary sector is the fact that the rigidity of the traditional mortgage contract means that such loan facilities do not respond to economic changes such as inflation. In most cases, these changes are not realistic. They may lead to inflation erosion to the lender or increase interest rates to the borrower (Gerardi & Li 2010). In the process of shifting from the plain vanilla mortgages, the adoption of non-interest only loan facilities has been upheld since these loans are not only responsive to economic forces and dynamics but also flexible and efficient to the economy (Ding, Quercia, & Ratcliffe 2010; Mills & Kiff 2007). One of the loan facilities in this category that have received much applause and support is the Continuous Workout Mortgage (CWM) whose properties and design will be discussed in this section in detail.

Despite the above-mentioned advantages and obvious merits of the CWMs over plain vanilla debts, several drawbacks to this arrangement are evident. For instance, the prevailing economic conditions may affect an individual’s ability to earn. This claim can be true if one loses a job and/or when a business fails to succeed. In such situations, no income on the part of the borrower is realized. Hence, the amount of payment that is required in the given month may be adjusted to zero. Further, a very low income on the part of the borrower might mean very little monthly contribution, which may increase the period of repayment drastically. Such situations have little financial value to the lender. Another key issue that is evident is the moral hazard. In this case, the CWMs are pegged on the assumption that individuals to the loan are going to act morally and responsibly towards meeting the responsibilities (Shiller et al. 2011). In other words, there is still more room for more work to refine the CWMs to make them truly viable and applicable alternatives to the existing plain vanilla debts. These debts have caused major havoc to the economy, the lenders, and borrowers due to their inefficiency and lack of responsiveness to market changes

Ethical Ways of Giving Mortgages

On the part of the borrower, apart from the lender’s trust in the individual is based on the creditworthiness of the borrower, goodwill is also a central aspect. In other words, lenders offer loans with the belief that the borrower will maintain his or her commitment up to the end of the bargaining by paying the whole amount with the agreed interest rate (Carroll & Buchholtz 2014). However, this observation is not always the case. In some cases, borrowers often default or walk away from the mortgages. This move is dishonorable and against ethical considerations that guide the industry. For instance, during the economic downtown of 2007/2008, many homeowners decided to walk away, rather than repaying the whole amount, which was way above the collateral amount due to the reduced housing prices (Liao 2009; DeLisle 2008). Such a situation reflects badly on an individual in terms of ethical procedures that should guide the industry.

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