Economics of Mortgage Termination in India

Mortgage termination due to prepayment is an important issue in pricing of mortgage and mortgage-backed securities (MBS) due to its stochastic nature. In developing countries where MBS is not yet fully developed, mortgage termination affects the flow of funds to the lenders. Recent literature has used option price models (OPM) to analyze prepayments. Prepayment is a ‘call option’ whose price is dependent on fluctuation in market interest rates. However, the termination of mortgage in housing is not as `ruthless’ as OPM theory would suggest, primarily because households are not financiers in `stricter sense’. Recent literature has used Cox proportional hazard model to model mortgage termination. The idea is that other household related variables besides option price of the instrument jointly determine the mortgage termination. We use Cox proportional hazard model to analyze prepayment of mortgage behaviour in India. The results indicate that financial concerns (like option price, loan to value ratio and monthly principal and interest to income ratio) are important determinants besides household characteristics. Self employed or low educated or single borrowers have less probability of prepaying the loan. An important variable inducing prepayment is irregular repayment behaviour of borrower. If loan repayment is in arrears for some months, borrowers’ often terminate their liability by prepaying. 1 This paper was completed when I was visiting Department of Urban Studies, University of Glasgow as Journal of Urban Studies Research Fellow during the summer of 1998. I would like to thank Professor Lever, Managing Editor for extending me an opportunity to work at University of Glasgow. My special thanks to Professor Edwin Deutsch, University of Technology, Vienna for suggestions and comments on empirical model.