Mortgage Choice Research Articles

The Borrower's Perceived Risk in Mortgage Choice

We investigate how borrowers perceive the risk in the adjustable rate mortgage (ARM) versus fixed rate mortgage (FRM) choice. We develop a mortgage choice model where the coefficient on the long‐term bond risk premium is conditional on the borrower's perceived risk. We show that the perceived risk fluctuates over time according to the short‐term interest rate level and housing market conditions. We find that when the short‐term rate level is high (low), the borrowers perceive low (high) risk of a short‐term rate rise, thus opting for ARMs (FRMs). Also, during a down housing market they become more risk‐averse perceiving higher risk in choosing ARMs. The perceived risk level alters the borrowers’ sensitivity to the long‐term bond risk premium.

Mortgage Choice Determinants: The Role of Risk and Bank Regulation

We shed new light on the role of borrower characteristics in mortgage product choice, and how these are impacted by regulatory capital requirements. Using rich loan‐level data from the Australian market, we analyse the borrower idiosyncratic risk effects on the choice between variable‐rate mortgages and other mortgages with reduced initial payments. We find that income, wealth and mobility risks play a role in product choice. We investigate regulatory capital requirements in a market where banks hold mortgage risk on balance sheet and find that the Basel capital discounts based on loan‐to‐valee ratios divide otherwise similar borrowers in their mortgage choices.

Home Ownership, Household Leverage and Hyperbolic Discounting

I examine tenure and mortgage choice in an equilibrium model in which households make decisions as if they discount hyperbolically rather than exponentially. Overall, hyperbolic discounting does not seem to explain the high rates of home ownership or portfolio concentration in housing in the data. I then study the choice between mortgages that require a substantial down payment and mortgages that require no down payment. Allowing households access to no‐down‐payment mortgages exacerbates rather than mitigates the undersaving of hyperbolic discounters. However, even when households discount hyperbolically, welfare is higher when households have access to no‐down‐payment mortgages.

Factors Influencing Choice of Mortgages between FRM and ARM: A Comparison of Koreans and Americans

Factors Influencing Choice of Mortgages between FRM and ARM: A Comparison of Koreans and Americans

The Exposure of Mortgage Borrowers to Interest Rate Risk and House Price Risk — Evidence from Swiss Loan Application Data

Summary We study the exposure of mortgage borrowers in Switzerland to interest rate and house price risks and examine how the households' choice of risky mortgages is related to individual interest rate expectations and risk-aversion. Our analysis is based on a unique data set of household mortgage applications from September 2012 until January 2014. Our assessment of risk exposure among mortgage borrowers in Switzerland is highly sensitive to the underlying assumptions on mortgage costs, household income and house value. Our main results suggest that the exposure of mortgage borrowers to interest rate and house price risks is limited in the medium term. We further document that the choice of mortgage contract seems to be more influenced by affordability concerns than risk concerns. In particular, individual interest rate expectations hardly affect mortgage contract choice.

Mortgage choice, house price externalities, and the default rate

We study the pathways by which borrowers and lenders influence house prices and default rates via their choices and offerings of fixed-rate and adjustable-rate mortgage products (FRMs and ARMs) in a two-period setting. We extend previous literature on mortgage choice as a tool for borrower risk screening under asymmetric information by incorporating house price externalities. The novelty in our setup is that house prices in the second period are negatively affected by the first-period default rate. We show that when these negative externalities are large, lenders may benefit by offering a lower ARM rate. This outcome, in turn, influences the likelihood of a separating equilibrium in which high-risk (low-risk) borrowers choose ARMs (FRMs) relative to a pooling equilibrium in which both high-risk and low-risk borrowers receive the same contract. When the impact of the negative house price externalities is small, it is more likely that lenders will offer pooling contracts; however, when the impact of the house price externalities is large, it is more likely that lenders will offer separating contracts. We also compare the equilibrium default rates across different contract offerings and find that when the negative house price externalities are large, the pooling FRM contract or the separating contract tends to offer the lowest default rate; however, when the negative house price externalities are small, the pooling ARM contract may result in the lowest default rate.

The Underwriting, Choice and Performance of Government-Insured Mortgages in Russia

This paper analyzes the mortgage borrowing process from a Russian state-owned provider of residential housing mortgages concentrating on the choice of having government insurance. This analysis takes into account the underwriting process and the choice of loan limit by the bank, the choice of contract terms and the performance of all loans issued from 2008 to 2012. Our dataset contains demographic, financial, loan terms and the performance information for all applications. We use a multistep nonparametric approach to estimate the determinants of bank and borrower choice. The main finding that the probability of having government insurance is linked to riskier loans, but insured loans also are more likely to be approved by the bank. The bank, when approving a borrower, takes into account not the probability of default but the difference between the probability of default and having government insurance.

Time Preferences, Mortgage Choice and Mortgage Default

The recent financial crisis has led to calls for a better understanding of the reasons behind the increase in mortgage defaults and the foreclosures that followed. Previous studies using option-based mortgage default models predicted that borrowers should immediately exercise the default option when the market value of their mortgage exceeds the value of the underlying property. However, empirical evidence shows that a substantial number of borrowers are unlikely to default as 'ruthlessly' as the option theory predicts. This indicates that mortgage borrowers are a heterogeneous group. In this paper, borrowers’ time preferences across mortgage choices are hypothesized as being heterogeneous. Borrowers can either have a present-biased preference (overvaluing immediate outcomes), or a time-consistent preference (standard exponential discounting). Borrowers with a present-biased preference are more likely to accept back-loaded mortgages that minimize up-front costs, even though this increases their risk of going underwater and entering default when negative home price shocks occur.

Mortgage Choice in the Housing Boom: Impacts of House Price Appreciation and Borrower Type

The U.S. housing boom during the first part of the past decade was marked by rapid house price appreciation and greater access to mortgage credit for lower credit-rated borrowers. The subsequent collapse of the housing market and the high default rates on residential mortgages raise the issue of whether the pace of house price appreciation and the mix of borrowers may have affected the influence of fundamentals in housing and mortgage markets. This paper examines that issue in connection with one aspect of mortgage financing, the choice among fixed-rate and adjustable-rate mortgages. This analysis is motivated in part by the increased use of adjustable-rate mortgage financing, notably among lower credit-rated borrowers, during the peak of the housing boom. Based on analysis of a large sample of loan level data, we find strong evidence that house price appreciation dampened the influence of a number of fundamentals (mortgage pricing terms and other interest rate related metrics) that previous research finds to be important determinants of mortgage financing choices. With regard to the mix of borrowers, the evidence indicates that, while low risk-rated borrowers were affected on the margin more by house price appreciation, on balance those borrowers tended be at least as responsive to fundamentals as high risk rated borrowers. The higher propensity of low credit-rated borrowers to choose adjustable-rate financing compared with high credit-rated borrowers in the housing boom appears to have been related to borrower credit risk metrics. Given the evidence related to loan pricing terms, other interest rate metrics and fixed effects, the relation of credit risk to mortgage financing choice seems more consistent with considerations such as credit constraints, risk preferences, and mortgage tenor than just a systematic lack of financial sophistication among higher credit risk borrowers.

The Myopic Choice between Fixed and Adjustable Rate Mortgages in Flanders

Many households have only one major asset, a house, which is usually financed through a mortgage contract. One of the most important financial decisions a household has to make is therefore the choice of mortgage type. These can be broadly described as falling into one of two categories: the fixed rate mortgage (FRM) and the adjustable rate mortgage (ARM). We use data from Flanders (Belgium) to study the choice between FRMs and ARMs. Belgium is of special interest as the structure of the Belgian mortgage market varied significantly during the last decade. From 2003 to 2012, the Belgian share of mortgages with an initial rate fixation period up to one year fell from 62% in 2004 to 8% in 2006, recovered to 58% in 2010, and fell again to 5% in 2012. This is a remarkably large variation in comparison to other countries. The results indicate that the FRM-ARM interest rate spread explains almost all the variation of the ARM share from 2003:01 to 2012:12. However, households do not distinguish between changes in the premium that lenders demand for holding the riskier long-term FRM or expected changes in the ARM rate. Mortgage choices can thus be described as short-sighted decisions, based on initial mortgage payments. We furthermore find evidence that high and low income households in Flanders choose an ARM for different reasons. Whereas the high income segment chooses an ARM if they can afford changes in interest payments, the low income households prefer an ARM if they are financially constrained.

Household Risk Management and Actual Mortgage Choice in the Euro Area

Les prets hypothecaires constituent la majeure partie de la dette des menages, et le choix d’un taux d’interet fixe ou variable represente une consideration essentielle au moment de contracter un tel pret. Cependant, jusqu’a maintenant, aucune etude multipays approfondie n’avait analyse les facteurs qui determinent la demande des menages a l’egard de chaque type de pret hypothecaire; c’est donc a cela que se sont attaches les auteurs en exploitant des donnees inedites sur la zone euro.

House-Price Expectations, Alternative Mortgage Products, and Default

August 2013, Revised December 2014 Rapid house-price depreciation and rising unemployment were the main drivers of the huge increase in mortgage default during the downturn years of 2007 to 2010. However, mortgage default was also associated with an increased reliance on alternative mortgage products such as pay-option and interest-only adjustable rate mortgages (ARMs), which allow the borrower to defer principal amortization. The goal of this paper is to better understand the forces that spurred use of alternative mortgages during the housing boom and the resulting impact on default patterns, relying on a unifying conceptual framework to guide the empirical work. The conceptual framework allows borrowers to choose the extent of mortgage “backloading,� the postponement of loan repayment through various mechanisms that constitutes a main feature of alternative mortgages. The model shows that, when future house-price expectations become more favorable, reducing default concerns, mortgage choices shift toward alternative products. This prediction is confirmed by empirical evidence showing that an increase in past house-price appreciation, which captures more favorable expectations for the future, raises the market share of alternative mortgages. In addition, using a proportional-hazard default model, the paper tests the fundamental presumption that backloaded mortgages are more likely to default, finding support for this view.

The Effect of Down Payment Assistance on Mortgage Choice

Lack of wealth for a down payment is one of the most recognized barriers to home ownership. In response to this barrier, state and federal government have implemented many programs that provide down payment assistance to potential home buyers. Numerous studies have shown that this assistance can increase homeownership rates, but few have measured how receiving assistance may alter borrowing behavior. Using data from a down payment assistance grant in the Midwest, this study compares the loan type and size of grant recipients to other borrowers that report similar income and buy homes in the same census tract. Results indicate grant recipients are more likely to use conventional loans, which are less expensive than other loan types that require a smaller down payment. Estimates also suggest that the grant may reduce loan size for borrowers who are on the margin of using a conventional loan.

Can home-owners benefit from stochastic programming models? A study of mortgage choice in Denmark

The Danish mortgage market is large and sophisticated. However, most Danish mortgage banks advise private home-owners based on simple, if sensible, rules of thumb. In recent years a number of papers (from Nielsen and Poulsen in J Econ Dyn Control 28:1267–1289, 2004 over Rasmussen and Zenios in J Risk 10:1–18, 2007 to Pedersen et al. in Ann Oper Res, 2013) have suggested a model-based, stochastic programming approach to mortgage choice. This paper gives an empirical comparison of performance over the period 2000–2010 of the rules of thumb to the model-based strategies. While the rules of thumb slightly outperform a passive benchmark on average and are less risky than pure adjustable rate loans, we find considerable gains from using the model-based strategies. Using a strategy that minimizes conditional-value-at-risk lowers average effective yearly interest rate over a 10-year horizon by 0.3–0.9 %-points (depending on the borrower’s level of conservatism) compared to the rules of thumb without increasing the risk. The answer to the question in the title is thus affirmative.

Why do Italian households prefer adjustable rate mortgages?

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.

Does Gender Affect Mortgage Choice? Evidence from the US

This study examines the effect of gender on the choice of adjustable- versus fixed-rate mortgages among mortgage applicants in the United States. While adjustable-rate mortgages (ARMs) are initially cheaper, they expose the borrower to interest rate risk. Using linear probability models applied to US lender data for 2004–6, the study finds that the propensity to apply for an ARM among higher-income applicants is lower for women by 3.7–8.4 percentage points or 12–42 percent. Results are robust to the inclusion of education, financial knowledge, and economic determinants of mortgage choice. Results are consistent with past findings of women being more risk averse than men in financial behaviors. Findings of this US-based study are relevant for other countries, as ARMs of varying lengths are widely prevalent outside the US.

Did Housing Policies Cause the Postwar Boom in Homeownership?

After the collapse of housing markets during the Great Depression, the U.S. government played a large role in shaping the future of housing finance and policy. Soon thereafter, housing markets witnessed the largest boom in recent history. The objective in this paper is to quantify the contribution of government interventions in housing markets in the expansion of U.S. homeownership using an equilibrium model of tenure choice. In the model, home buyers have access to a menu of mortgage choices to finance the acquisition of a house. The government also provides special programs through provisions of the tax code. The parameterized model is consistent with key aggregate and distributional features observed in the 1940 U.S. economy and is capable of accounting for the boom in homeownership in 1960. The decomposition suggests that government policies have significant importance. For example, the expansion in maturity of the fixed-rate mortgage to 30 years can account for 12 percent of the increase. Housing policies, such as the introduction of the mortgage interest deduction or the taxation of housing services can have significant effects on homeownership.

Income Risk and Mortgage Choice Among Japanese Households

This paper empirically examines the relationship between income risk and mortgage instrument choice among Japanese households. Since theoretical predictions about the impact of income risks on mortgage choice are mixed, it is important to investigate empirically whether or not risky households borrow ARM loans. In order to answer this question, we construct several measures of income variability and unemployment risk that capture the income risk of the specific household. Our empirical result suggests that these income risk measures are in general negatively associated with the choice of fixed-rate mortgage contract, indicating that risky borrowers are more likely to choose adjustable-rate mortgages. Furthermore, we also find that the impact of income risk on the mortgage choice depends critically on the individual risk preferences. While there is significantly negative impact of income variability and unemployment risk on the mortgage choice for the risk averse borrowers, no systematic relationship can be found for borrowers with low risk aversion.

Regional Differences in Mortgage Demand and Mortgage Instrument Choice in the UK

Koblyakova A., Hutchison N. and Tiwari P. Regional differences in mortgage demand and mortgage instrument choice in the UK, Regional Studies. This paper presents empirical evidence of regional variations in mortgage choice decisions within the UK's mortgage sector. Utilizing British Household Panel Survey (BHPS) data for the years 2001, 2007 and 2008, the paper suggests that a household's decision to choose a variable rate mortgage is more likely to occur in areas with lower incomes and affordability rates, such as Northern England, Scotland and Wales. Since variable rate mortgages are more sensitive to income and monetary policy shocks, the disproportional distribution of variable contracts within the mortgage sector may have a differential impact on the regions.

What Calls to ARMs? International Evidence on Interest Rates and the Choice of Adjustable Rate Mortgages

The relative popularity of adjustable-rate mortgages (ARMs) and fixed-rate mortgages (FRMs) varies considerably both across countries and over time. We ask how movements in current and expected future interest rates affect the share of ARMs in total mortgage issuance. Using a nine-country panel and instrumental variables methods, we present evidence that near-term (one-year) rational expectations of future movements in ARM rates do affect mortgage choice, particularly in more recent data since 2001. However longer-term (three-year) rational forecasts of ARM rates have a relatively weak effect, and the current spread between FRM and ARM rates also matters, suggesting that households are concerned with current interest costs as well as with lifetime cost minimization. These conclusions are robust to alternative (adaptive and survey-based) models of household expectations.