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Exploring Mortgages: FPM vs. VPM and Their Impact on Property Financing

This guide delves into the intricacies of mortgages, focusing on two key models: Fixed Payment Mortgages (FPM) and Variable Payment Mortgages (VPM). It explains how borrowers can secure loans for property purchases, using real estate as collateral. The document contrasts the characteristics of both mortgage types, highlighting issues such as payment structures, consumer optimization, and the effects of moving costs. It also addresses economic concepts like compensating and equivalent variations, providing insights into the implications of pre-payment penalties and how they influence borrower behavior.

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Exploring Mortgages: FPM vs. VPM and Their Impact on Property Financing

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  1. Mortgages – FPM, VPM

  2. Mortgages • Borrow $ because property owner wants the money NOW. • Put the property up as security for the loan. • Mortgage = A loan to finance the purchase of real estate, usually with specified payment periods and interest rates. The borrower (mortgagor) gives the lender (mortgagee) a lien on the property as collateral for the loan.

  3. Simple Multi-period FP Model Optimize with respect to h and z.

  4. FP Mortgage Eq’m In contrast to more flexible analysis, consumer optimizes w.r.t. discounted average price ratio. Opportunity to save or borrow allows MU of income to converge.

  5. Simple Multi-Period VP Model Optimize with respect to hi, ciand zi.

  6. Parameters Moving cost = 1

  7. FP – Mortgage – No Moves FP – Mortgage – Moves VP – Mortgage – No Moves

  8. Comparative Housing

  9. Comparative Payments

  10. Comparative Income Burdens

  11. What are the differences? • Compensating variation (take money) = 2.310 • Equivalent variation (give money) = 2.060

  12. What does it all mean? • FPM frontloads payments. • VPM evens out payments. Leads to information problems. • We can do something with this by requiring people to stay in the house with a pre-payment penalty. • Solves the information problem as to who really wants to stay in the house.

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