Why do Italian households prefer adjustable rate mortgages?

Abstract

PurposeIn Italy three quarters of the stock of households' mortgage debt is exposed to interest rate risk. The aim of this paper is to explain why the majority of mortgage holders in the Italian residential mortgage market have chosen a mortgage with a variable interest rate.Design/methodology/approachThe empirical analysis has been carried out on a sample of 959 Italian households on the basis of data from the Survey on Household Income and Wealth by the Bank of Italy and covers the period between 1997 and 2006.FindingsThe outcomes raise some doubts about the efficiency of the Italian mortgage market in terms of risk allocation between banks and householders. Fixed rate mortgage (FRM) versus adjustable rate mortgage (ARM) choice appears to be guided by a short‐term outlook informed by the need to maximize a household's immediate utility. Furthermore, households seem to embrace a myopic perspective, since the preference for ARMs increases with the lengthening of the maturity of the mortgage and with any increase in the size of the principal amount. Also, lending policies appear to have a considerable influence on a household's FRM‐ARM choice.Practical implicationsIt seems that the Italian mortgage market requires adequate initiatives to improve households' financial literacy. Some measures to mitigate the assumption of the interest rate risk by households would be also welcomed.Originality/valueThis study represents the first investigation into the relationship between lending policies of banks and householders' mortgage choice from the perspective of a country distinguished by a high and persistent preference for the adjustable rate mortgages.