"The 2/28 Mortgage: When Business and Psychology Intersect in a New Consumer Product"
2011
Publication type: Case study
Research Archive Topic: Business Economics and Public Policy, Corporate Finance, Real Estate
Abstract
As the subprime mortgage market flourished in the 1990s, innovative lenders turned to a new type of loan: the 2/28 mortgage, designed to allow borrowers with less-than-ideal credit to buy a home and to repair their credit histories. This mortgage offered a fixed two-year "teaser" rate, followed by 28 years of payments that would adjust according to market rates such as LIBOR. As an example shows, the teaser rate was relatively affordable, but when the adjustable rate kicked in, borrowers might see their monthly payments eventually increase by as much as 50 percent. Lenders saw this type of loan as a temporary fix; borrowers were expected to refinance as their credit scores improved. This case discusses aspects of consumer psychology — specifically, the personal discount rat — in light of the popularity of the 2/28 mortgage, and later, its extraordinarily high default rate once housing prices collapsed.
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