Comparison of mortgage products by associated risks

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Dr. Telcs András
Department of Computer Science and Information Theory

The two main causes of mortgage payment difficulties are rising house prices and a temporary loss of household income. Currently available bank products handle these problems only when the mortgage is already delinquent (usually for a long time). The so-called workout process that starts at this point usually results in either loan restructuring or termination.

A number of ideas and initiatives are present in the literature which brings this expensive workout process earlier and in an automatic fashion, thereby making it more predictable and less expensive for both sides. By using an embedded optionality in the mortgage product it is possible to reduce scheduled payments or the balance itself with the decline of the value of the property offered as collateral.

The paper aims to create a theoretical model and its simulations on mortgage products with an above mentioned embedded optionality and to propose a fair pricing method. A few mortgage construction proposals found in the literature are then compared using the above created model.


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