Mexican housing authority the Sociedad Hipotecaria Federal (SHF) announced a plan June 2 to discontinue the origination of inflation-indexed mortgages, or UDI loans, in 2011.

The agency also introduced a new mortgage product called the “Defined Payments” mortgage, which is aimed at providing low-income borrowers with more payment certainty than UDI loans.

Moody’s believes that this new product is “credit positive for the Mexican mortgage sector as it will provide low-income borrowers with an attractive mortgage refinancing option that will result in higher prepayments on outstanding securitized UDI mortgage pools and lower lifetime losses.”

In an UDI mortgage, both the nominal mortgage balance and monthly payments rise in tandem with inflation. For lower-income borrowers, the unpredictability of the payments, as well as negative amortization, can be a difficult to handle. And this strata of borrowers has often been the target for UDI mortgages, given that the initial monthly payments tend to be lower than in peso-denominated loans.

The upshot is that UDI loans comprise the lion’s share of mortgage defaults during the recent economic crisis.

As seen in the chart below, two transactions with similar credit characteristics originated by nonbank lender Su Casita in 2007 showed pronounced differences in performance. The UDI-loan deal did far worse than the peso-loan one.

Moody’s expects that the new Defined Payments product will have lower delinquencies than UDI transactions but will not match the performance of peso deals.

“Every three years, for a pre-determined number of years, the rate (on a Defined Payments loan) will increase and the mortgage payment will adjust upwards by a maximum of 4% annually,” the rating agency said. “By limiting up front the frequency and extent of changes in monthly payments, the resulting “shock” of increased monthly payments…should be muted.”

But since the Defined Payments mortgages will attract lower-income borrowers because of their lower initial payments, the peso loans — with its greater appeal to higher-income borrowers — should keep outperforming the alternative.

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