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Values of Mortgages with Top-up Payment Options
Rose Neng Lai1; Seow Eng Ong2; Tien Foo Sing2
2006-08
Source PublicationInternational Journal of Theoretical and Applied Finance
ISSN0219-0249
Volume99Issue:05Pages:801-824
Abstract

The right of lenders to request for top-ups of negative equity when the property value falls below the loan outstanding is a little known, yet widely adopted provision in mortgage documents in many Asian markets. We analyze the effect of the top-up option by appealing to a contingent claim framework. Specifically, we model the top-up option as a synthetic option comprising a long put to request for a top-up, a short put that cancels out the first option in the event of a default, and a binary put option once triggered will yield a value equivalent to the difference between the mortgage outstanding and the property value. The results of comparative analyses show that the lender's right to request for top-ups is valuable when the negative mortgage equity increases, especially in a market where price is highly volatile. The top-up clause fundamentally affects the mortgage values for both the borrower and the lender. We show that lender's inaction by not calling for top-ups when negative mortgage equity occurs is suboptimal. On the other hand, the lenders' exercise of the in-the-money top-up options may lead to early default by the mortgagor. This is one of the reasons why lenders exercise this option only very sparingly in practice. This mortgage design has economic value to the lenders, it is, however, not optimal in time of volatile market. The policy implication of the findings is that the sub-optimal top-up feature should be removed from the mortgage contract, and it will not severely jeopardize the lender's ability to enforce payments in the mortgages.

KeywordNegative Equity Top-up Options Mortgage Default
DOIhttps://doi.org/10.1142/S0219024906003779
Language英语
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Document TypeJournal article
CollectionFaculty of Business Administration
DEPARTMENT OF FINANCE AND BUSINESS ECONOMICS
Affiliation1.University of Macau
2.National University of Singapore
First Author AffilicationUniversity of Macau
Recommended Citation
GB/T 7714
Rose Neng Lai,Seow Eng Ong,Tien Foo Sing. Values of Mortgages with Top-up Payment Options[J]. International Journal of Theoretical and Applied Finance,2006,99(05):801-824.
APA Rose Neng Lai,Seow Eng Ong,&Tien Foo Sing.(2006).Values of Mortgages with Top-up Payment Options.International Journal of Theoretical and Applied Finance,99(05),801-824.
MLA Rose Neng Lai,et al."Values of Mortgages with Top-up Payment Options".International Journal of Theoretical and Applied Finance 99.05(2006):801-824.
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