Borrowing and Spending in the Money: Debt Substitution and the Cash-out Refinance Channel of Monetary Policy

Abstract

We show that the strong negative effect of higher mortgage rates on cash-out refinancing reflects substitution into other borrowing products, not large changes in total new household borrowing. We exploit an exogenous increase in long-term rates to show that, in the cross-section of outstanding mortgage rates, changes in cash-out and alternative borrowing are offsetting. Additionally, we instrument using monetary policy surprises to show that, over the period from 2006-2021, changes in cash-out refinancing are offset by alternative borrowing. Our results suggest that debt substitution substantially weakens the cash-out refinance channel of monetary policy and reduces its path-dependence.