Alternative Mortgage Instrument – Definition

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Alternative Mortgage Instrument (AMI) Definition 

An Alternative Mortgage Instrument (AMI) is any type of non-conventional mortgage agreement that does not specify a fixed interest rate or an amortization schedule or the terms of repayment. The following are a few examples of Alternative Mortgage Instruments:

  • Adjustable Rate Mortgage (ARM)
  • Shared Appreciation Mortgage (SAM)
  • Graduated Payment Mortgage (GPM)
  • Growth Equity Mortgage (GEM)

AMIs such as adjustable-rate mortgages and hybrid mortgages are typically secured by real estate.

A Little More on What is an Alternative Mortgage Instrument

Alternative Mortgage Instruments (AMIs) are usually preferred by investors that are unable to afford regular mortgage because of high interest rates and as such, residential mortgage loans constitute a major chunk of AMIs. Alternative mortgage instruments not only reduce monthly payment installments but also enable borrowers to finance higher prices. It is for this reason that AMIs are widely preferred by middle-class home buyers in their quest for more affordable housing. Besides, AMIs are also popular among larger groups of investors seeking to invest in real estate.

Since AMIs are non-fixed interest mortgage loans, they usually involve lower monthly installments in the initial phases compared to fixed interest mortgage loans. However, the interest rate fluctuates over time to reflect changes in the real estate market. In the case of Adjustable Rate Mortgages (ARMs), the interest rate climbs periodically. Similarly, a lender of Shared Appreciation Mortgages (SAMs) compensates for the lower initial interest rate by subsequently raising it in keeping with appreciating property value. In case of Graduated Payment Mortgages (GPMs), the mortgages carry average interest rates, but differ in the installment amounts. Lenders offering such mortgage loans usually raise the interest rates after a specified period. Growing equity mortgages (GEMs) are similar to graduated payment mortgages wherein the installments gradually increase over time. However, unlike GPMs, GEMs earn money by depositing the excess payment into a retirement fund for the borrower.

Timeline of Alternative Mortgage Instruments

Alternative Mortgage Instruments (AMIs) first rose in popularity in the early 1980s as viable alternatives to conventional mortgage loans that usually commanded high interest rates. The lower mortgage payments associated with AMIs, in a way, revolutionized the housing market by making mortgage loans accessible to several first-time homebuyers. Alternative Mortgage Instruments also made it possible for homebuyers to finance more expensive properties.

The first five years of the new millennium saw a significant drop in interest rates, which directly resulted in record home sales. As a result, banks and other financial institutions introduced more Alternative Mortgage Instruments (AMIs) with added features such as lower down payments and up to 100 percent financing. Besides, the period from 2001 to 2005 saw the emergence of AMIs with longer-term amortization schedules, variable-rate mortgages, graduated-payment mortgages, and reverse-annuity mortgages.

Illustration of an Alternative Mortgage Instrument

Suppose, the Andrews are looking to purchase their first home for $300,000. Being unable to afford a standard 30-year fixed-rate mortgage, the family instead settles for an Adjustable Rate Mortgage (ARM), specifically a 5/1 ARM. A 5/1 Adjustable Rate Mortgage has a fixed rate for the first five years and then transforms into an adjustable-rate mortgage for the remaining term. Now, the Andrews’ home is expected to increase in value during the first five years. This provides the family the opportunity to switch to a more conventional fixed rate mortgage loan before the ARM payments increase.

References for Alternative Mortgage Instrument

Academic Research

Borrower risk under alternative mortgage instruments, Webb, B. G. (1982). Borrower risk under alternative mortgage instruments. The Journal of Finance, 37(1), 169-183. This paper analyzes differences in borrower risk under alternative mortgage instruments and various borrower characteristics. The traditional approach of measuring borrower risk in terms of actual delinquency and foreclosure data is rejected in favor of a model based on potential delinquency‐that is, changes in the mortgage payment to income ratio. The combinations of mortgage terms and borrower characteristics that are most likely to produce a potential delinquency are isolated based on the calculation of hypothetical payment to income ratios over an eight year period.

Default risk under alternative mortgage instruments, Vandell, K. D. (1978). Default risk under alternative mortgage instruments. The Journal of Finance, 33(5), 1279-1296.

Alternative mortgage instruments: their effects on consumer housing choices in an inflationary environment, Alm, J., & Follain Jr, J. R. (1982). Alternative mortgage instruments: their effects on consumer housing choices in an inflationary environment. Public Finance Quarterly, 10(2), 134-157. This article compares the effects of the standard fixed-payment mortgage instrument (SMI) and the graduated-payment mortgage instrument on an individual’s housing decisions in an inflationary environment. Using a simulation model of life-cycle consumer choice, the results with the SMI suggest that low to moderate rates of inflation increase housing demand but rates in excess of 10% have the opposite effect. The results also suggest that the GPM has the potential to increase substantially housing demand, with households willing to pay moderate premiums in order to obtain GPMs.

Homeownership effects of alternative mortgage instruments, Follain, J., & Struyk, R. (1977). Real Estate Economics, 5(1), 1-43. Most of the interest in alternatives to the standard mortgage instrument has centered on the ability of the alternatives to improve on the performance of the mortgage instrument over the business cycle. The focus in this paper is on the long‐term effects on homeownership rates and associated additional residential construction. The instruments are found to offer potentially large increases in homeownership rates by reducing monthly mortgage payments. Widespread adoption of those instruments causing larger payment reductions would allow around one million more households to become owner‐occupants. The demand for new single‐family homes would increase over the long run by 3 to 4 percent a year. Homeownership could be further increased by a time‐limited subsidy directed at moderate income families.

Estimation of mortgage defaults using disaggregate loan history data, Vandell, K. D., & Thibodeau, T. (1985), 13(3), 292-316. This paper addresses, theoretically and empirically, the structure of influences affecting the default option in mortgage contracts. A formal theoretical model recognizes that a number of loan and non‐loan related effects beyond equity in the unit could influence the default decision. These include 1) payment levels relative to income, which could displace other investment opportunities or cause a need for borrowing or sale to meet mortgage obligations; 2) current and expected neighborhood and housing market conditions, in particular the expected relative rate of appreciation of the unit and the relative cost of homeownership; 3) economic conditions; 4) wealth; 5) borrower characteristics proxying for variability in income or “crisis” events; as well as 6) transactions costs incurred upon default. Estimates of the model making use of a micro‐level sample of individual loan histories over a twelve year period, supplemented by longitudinal census and economic information, find a number of these “other” effects important. Simulations find several of them to dominate the equity effect on default and to help explain why some households with zero or negative equity may not default, while others with positive equity may. The implications of these results for appropriate specification of the pricing model describing the default option and for appropriate underwriting of AMIs are noted.

Borrower Attitudes Toward Alternative Mortgage Instruments, Colton, K. W., Lessard, D. R., & Solomon, A. P. (1979).  Real Estate Economics, 7(4), 581-609. Much of the existing literature on homeownership assumes that financial markets work well enough to allow households to translate permanent income into effective demand. However, transaction costs, imperfections, and uncertainties all constrain the markets’ operation so that people are often forced to choose a quantity of housing stock that diverges from their desired consumption level. Instead of being able to borrow against future income for the down payment or to make monthly payments in a pattern that matches future income, young families in their early years may be constrained from purchasing the size house they desire, and older households may remain in homes larger than they need. In light of these market imperfections, housing and tenure decisions depend not only on permanent income and the relative price of housing services, but also on such mortgage parameters as monthly payment patterns, down payment, and rate of equity accumulation. Models of the demand for housing and homeownership described in the existing literature do not include these parameters of mortgage finance. Mortgage terms are important factors in housing consumption and investment decisions. Because the standard mortgage no longer seems appropriate for all households under all economic conditions, the extent to which alternative mortgage instruments meet the requirements and preferences of different segments of the market becomes an important issue.

Alternative Mortgage Instruments and Potential Mortgage Enforcement Problems, Freeman, P. L. (1982). The Urban Lawyer, 760-764.

The New Mortgages: A Functional Legal Anaylsis, Caswell, C. (1982). The New Mortgages: A Functional Legal Anaylsis. Fla. St. UL Rev., 10, 95.

Tax expenditures and other programs to stimulate housing: Do we need more?, Alm, J., Follain, J. R., & Beeman, M. A. (1985). Tax expenditures and other programs to stimulate housing: Do we need more?. Journal of Urban Economics, 18(2), 180-195. Discussions to aid the housing industry raise several questions. First, does stimulation of housing demand require new direct subsidy programs? And, second, are any programs to increase demand worth their costs to society? The results in this paper indicate that the answer to both questions is no: the existing subsidy to homeownership in the tax code is, when combined with mortgage instruments that offset cash flow problems, fully capable of generating large increases in demand at the cost of significant tax expenditures; and the social benefits of increased housing demand are shown to be worth only about 60% of their costs. Consequently, increasing housing demand can be readily achieved, but doing so will be costly to the government and inefficient for society.

Alternative Mortgage Instruments in California, Washburn, E. S. (1978). Alternative Mortgage Instruments in California. Akron L. Rev., 12, 599.

Alternative Mortgage Instruments: Authorizing and Implementing Price Level Adjusted Mortgages, Goldberg, J. J. (1982). Alternative Mortgage Instruments: Authorizing and Implementing Price Level Adjusted Mortgages. U. Mich. JL Reform, 16, 115.

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