Abstract
Households face complicated financial choices with respect to housing, one of which is the choice of type of mortgage, if any, to use when purchasing a property. This is rendered all the more complex by the great variety of mortgage contracts (mortgage instruments available). Yet mortgage choices also involve the decision on how fast to repay, whether to pay off the debt early, refinance, or even default on the loan. This article looks at those approaches to the analysis of mortgage choice based upon the rational utility maximising framework of economics. Mortgage demand, or the size of debt, is also central or related to these decisions. Brueckner (1994) has made a significant contribution to the analysis of mortgage demand under certainty and uncertainty and these models are often used to guide empirical analysis. There is also much formal modelling of the choice of mortgage instrument, including the risky context of this choice involving variable house prices, interest rates, and incomes. The analysis of prepayment and default decisions (assuming that they are voluntary choices) has been important for the valuation of securitised mortgage debt, but also for understanding household behaviour. The key theme of this article is that all of these decisions, with their sophisticated theoretical and econometric models, are very much interrelated. Imperfect capital markets and imbalances of information underpin this interdependence. Though other approaches to decision making, both psychological and sociological, are important, the classical approach can still offer great insight into the logic of this critical set of financial choices.
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