Assessment of fixed rate mortgage implied insurance cost: Method and ex-post Swiss market analysis
||Assessment of fixed rate mortgage implied insurance cost: Method and ex-post Swiss market analysis
||19th Annual European Real Estate Society Conference in Edinburgh, Scotland
||A huge part of housing finance is related to mortgage. In Europe, loan-to-value range between 50% and 85% for mortgage while the mortgage market/GDP ratio increased by 20% in 2010. In most developed countries housing is the most important household's investment or expenditure. This investment is generally leveraged by mortgage borrowing. The mortgage can bear fixed or variable interest rate; both with their pros and cons. Fixed rate allows easier budgeting over years since the bank bear the interest rate risk. This property of fixed rate mortgage is often assimilated to insurance that hedge against monthly payment fluctuation. Usually, initial variable rate is cheaper since the interest rate risk is assumed by the borrower. Yet, there has been surprisingly little work on mortgage decisions from the perspective of the household. Instead, most research on mortgages has been conducted by real estate or fixed-income securities specialists who are interested in pricing mortgage-backed derivatives. This paper proposes a method to assess the relative cost of fixed rate mortgage implied insurance for the borrower. Thus, we link the insurance cost with insurance premium concept and the related hedged risk. The proposed method is applied to Swiss data. This method offers a sound's basis for comparison of the cost of fixed mortgage rate in time and among countries. It also allows the exploration of the relationship between fixed rates implied insurance cost and people's preference for the financial product. We use the method to analyse mortgage rate between 2002 and 2012. We compare variables rates (Libor and bank variable rate) with five and three years fixed rate. We find that most of the time fixed implied insurance is costly for the borrower. This cost represents a value between 0.5% and 7% of the total initial mortgage when compared with libor.
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||PhD Session 2A
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