| Abstract: |
This paper seeks to fill a gap in the real estate finance literature by linking the well-known
history of the Anglo-American mortgage recorded by legal scholars with the recent
literature on security design and incomplete contracting in order to explain and evaluate several
unique features of the mortgage. In particular, we investigate how a conditional transfer of
ownership to a lender and the institution called the equity of redemption affect mortgage
renegotiation and therefore the value of mortgaged real estate. Given the governance of the
common law mortgage, we show that a mortgagor may not be able to renegotiate his mortgage
debt in order to delay repayment when faced with a re-investment opportunity during the life of the
mortgage. The failure to optimally renegotiate the mortgage does not necessarily result in
foreclosure but may result in underinvestment. Therefore, an additional period of time between
default and foreclosure, known as a period of equitable redemption, may allow the mortgagor to
accrue sufficient cash flow to not only avoid foreclosure but to mitigate underinvestment in non-
default states. Since this extra period of time may not be achievable ex post due to a hold-up
problem, its inclusion ex ante may be welfare improving.
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