Aggressive lending, real estate markets

July 12, 2007

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New teaser-rate mortgages and those with 35-year or longer amortization periods—or no amortization—are putting upward price pressure on the U.S. real estate market during boom periods and magnifying price declines during unfavourable economic periods.

These are the findings of a recent empirical study by SFU Business associate professor Andrey Pavlov.

The study, Aggressive Lending and Real Estate Markets, was authored by both Pavlov and Susan Wachter of the Wharton School of Business at the University of Pennsylvania, where Pavlov is currently a visiting professor.

It’s a disturbing trend, say the researchers, since industry sources suggest that aggressive lending instruments, such as interest-only loans, negative-amortization loans, low- or zero-equity loans, and teaser adjustable-rate mortgages account for nearly two-thirds of all U.S. loan originations since 2003.

The result, they say, is that neighborhoods and cities that experienced a high concentration of aggressive lending instruments at their respective real estate market peaks later suffered more severe price declines.

"It’s the variability in the supply of these aggressive lending instruments that is negatively affecting the real estate markets," says Pavlov. "They’re only available during favourable economic conditions. When there’s a negative-demand shock, driven by changing economic or psychological factors, then there is a severe re-pricing of these mortgages and a reduction in their availability."

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