Time-varying repayment contracts for financial resilience in mortgage lending

This paper develops time-varying repayment mortgage contract designs based on borrower income expectations and risk profiles over loan age. These contract designs differ between loans and are based on growing annuities. We benchmark these contracts to the traditional 30-year fixed-rate mortgage contracts. The proposed contract innovations reduce illiquidity but increase leverage due to payment delays. The combined effects reduce the probability of default, systematic risk, and regulatory capital. Due to the risk reduction, lenders can increase the gross return on regulatory capital by 10 percent, or alternatively, borrowers may benefit from credit spreads that are 17 basis points lower. Overall, our contracts enhance the resilience of mortgage markets. JEL: G01; G20; G21; C51, C55