Comparison of Two Affordable Housing Finance Channels

Abstract

This paper demonstrates, theoretically and empirically, that shared equity mortgages are a better affordable housing solution than high-leverage lending, in terms of both default reduction and cost to mortgage insurers. Their effectiveness in reducing strategic default is increased when shared equity contracts are conducted in expensive house price areas, during housing bubble periods, with long holding terms, or for borrowers with high expected returns. The paper develops numerical examples with the use of simulation and back-testing, which are applied to Los Angeles. The results show that Los Angeles could have avoided many of its strategic defaults in the recent recession if it had used a shared equity mortgage as an alternative to conventional low down-payment mortgages.

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Keywords

Strategic defaults, Shared equity mortgage, Affordable housing

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