Mortgage Choice Research Articles

Mortgage Choice as a Natural Field Experiment on Choice under Risk

Data on approximately 280,000 borrowers from the UK Survey of Mortgage Lenders are used to model choices between variable and fixed rate mortgages. The choice is assumed to depend on three factors: risk attitude, interest‐rate expectations, and individual discount rate. The ordered probit model is used for estimation, while taking account of a number of econometric issues including missing counterfactuals, selectivity, and endogeneity. A large number of strong effects are found, including: higher income borrowers are less risk averse and have a lower discount rate, and risk aversion rises with the amount borrowed, providing evidence of increasing relative risk aversion.

Prepayment Penalty as a Screening Mechanism for Default and Prepayment Risks

The objective of this article is to offer a theoretical model of asymmetric information to analyze the screening role of prepayment penalty. We consider both default risk and prepayment risk. What makes the role of prepayment penalty interesting and more complicated is that a borrower's contract choice could send conflicting signals to the lender about that borrower's default and prepayment risk type. This is different from earlier theoretical models of mortgage choice under asymmetric information where a certain aspect of the contract (e.g., discount points or loan‐to‐value ratio) is explored as a screening mechanism for a single risk dimension (default risk or prepayment risk) of the borrower type. We show the existence of separating equilibria where different default and prepayment risk types choose contracts with different combinations of prepayment penalty and interest rate. For certain parameter combinations, the model also generates a pooling equilibrium where all borrower types obtain the same contract. Our analysis could offer a partial explanation for the observation that contracts with prepayment penalties are a lot less prevalent than contracts with points.

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.

The Effect of Financial Literacy on Mortgage Choices

A growing body of literature shows that financial literacy affects household savings and investment choices. Less attention has, however, been devoted to its effect on debt behavior. This paper contributes to filling this gap by considering how financial literacy influences household attitudes with respect to the most common of family debts, the house mortgage. Using Italy as a case study, it considers the effect of financial literacy on three mortgage-related decisions, namely, the choice of lender and the decision between adjustable and fixed interest rates, as well as situations of mortgage misconduct. We find that the more financially literate individuals are, the more likely they are to shop around and compare mortgages for better economic conditions (in contrast to the less financially literate, who tend to take on mortgages from the first financial intermediary they contact), the more prepared they are to diversify risks by better connecting their risk exposure with different types of mortgage, and the less likely they are to experience delays in repayments.

Unobservable Risk in Mortgage Contract Selection Basket and its Role in Ex-Post Default

This study releases assumptions on previous borrowers’ mortgage choice under information asymmetric: exogenously known default risk and lenders’ zero profit. Through maximizing borrowers’ life-time utilities in housing and non-housing consumption, simulation results show that borrowers’ observable choices basket of mortgage type, preferred LTV, and house size, could reflects unobservable and unverifiable risk factors like real income, wealth, credit worthiness, and housing consumption preference. Further empirical tests, based on individual mortgages from non-agency residential mortgage backed securities, show that some mortgage selection baskets could systematically reflect t unobservable risk factors, which should not be ignored in analyzing mortgagors’ ex-post default. The results also suggest the requirements on understanding borrowers’ incentives and the necessity to gain more borrowers’ information on mortgage’s risk management. This paper might provide broader understanding from individual borrowers’ behaviors at micro-level to explanation on massive defaults in subprime crisis of potential real income story at macro-level.

Interest Rate Risk Perception in Households’ Mortgage Choice Decision

This paper examines households’ interest rate risk perception when choosing between fixed rate mortgages (FRMs) and adjustable rate mortgages (ARMs). The empirical analysis, carried out on the basis of data from the Survey on Household Income and Wealth by the Bank of Italy, highlights pervasive biased behaviours. First, the FRM-ARM choice appears to be influenced by the prospect of immediate savings. Second, due to households’ short term view, as the maturity is extended and the borrower’s risk is increased, then the preference for ARMs increases. Third, lending policies have a considerable impact on the FRM-ARM choice.

Why is the Market Share of Adjustable-Rate Mortgages so Low?

Over the past several years, U.S. homebuyers have increasingly favored fixed-rate mortgages over adjustable-rate mortgages (ARMs). Indeed, ARMs have dropped to less than 10 percent of all residential mortgage originations, a near-record low. One might speculate that the decline in the ARM share has been driven by one-off factors relating to the financial crisis. However, a statistical analysis suggests that recent trends can largely be explained by the same factors that have historically shaped mortgage choice - most notably, the term structure of interest rates and its effects on the relative price of different types of mortgages. Supply-side factors, in particular a rise in the share of mortgages eligible to be securitized by the housing government-sponsored enterprises, also play a role in the low current ARM share.

Mortgage Choices and Housing Speculation

We describe a rational expectations model in which speculative bubbles in house prices can emerge. Within this model both speculators and their lenders use interestonly mortgages (IOs) rather than traditional mortgages when there is a bubble. Absent a bubble, there is no tendency for IOs to be used. These insights are used to assess the extent to which house prices in US cities were driven by speculative bubbles over the period 2000-2008. We flnd that IOs were used sparingly in cities where elastic housing supply precludes speculation from arising. In cities with inelastic supply, where speculation is possible, there was heavy use of IOs, but only in cities that had boom-bust cycles. Peak IO usage predicts rapid appreciations that cannot be explained by standard correlates and this variable is more robustly correlated with rapid appreciations than other mortgage characteristics, including sub-prime, securitization and leverage. Where IOs were popular, their use does not appear to have been a response to houses becoming more expensive. Indeed, their use anticipated future appreciation. Finally, consistent with the reason why lenders prefer IOs, these mortgages are more likely to be repaid earlier or foreclose. Combined with our model, this evidence suggests that speculative bubbles were an important factor driving prices in cities with boom-bust cycles.

Empirical Evidence on Mortgage Choice as a Screening Mechanism for Default Risk

This paper examines one of the most critical credit decisions made by consumers:selecting between a fixed-rate mortgage (FRM) and an adjustable-rate mortgage (ARM).This study employs a sample of 1,003 mortgage loans to empirically evaluate whether aborrower's choice between fixed and adjustable rate products is contingent upon boththeir transactions costs of default and default risk. The findings reveal that when aborrower's default costs are sufficiently small, high default risk borrowersdisproportionately self-select into FRMs, while low default risk borrowers tend to selfselectinto ARMs.

Subprime Mortgages, Mortgage Choice, and Hyperbolic Discounting

Subprime Mortgages, Mortgage Choice, and Hyperbolic Discounting

Gender and Mortgage Choice: More Evidence on Gender Based Risk Aversion

We study the effect of gender in a new financial behavior context: the choice of a mortgage. While adjustable rate mortgages are initially cheaper, they expose the borrower to interest rate risk. Using national lender data, we find that propensity to apply for an adjustable rate mortgage among higher income applicants is 2.6-10 percentage points, or 10-50%, lower for women. Results are robust to inclusion of education and financial determinants of mortgage choice. We also find that among ARM applicants, women show propensity for contracts with longer initial fixed rate period. Results are consistent with past findings of females being more risk averse than males, as well as financial literacy increasing with income and wealth.

Psychological and Cultural Factors in the Choice of Mortgage Products: A Behavioral Investigation

Using data from three countries that differ economically, culturally, and geographically, this study examines the role of Prospect Theory's reflection effect, a psychological factor, in combination with Uncertainty Avoidance (UA), a cultural factor, on the choice of mortgage products. Experiments were conducted using business professionals in the United States, Germany, and Japan. The results suggest that risk-averse people tend to become more risk seeking, leaning more toward adjustable-rate mortgages (ARMs) when choosing a mortgage type, and that this psychological effect may underlie the mortgage choices of people who tend to choose ARMs, even across countries with different cultures.

Choice of Mortgage Contracts: Evidence from the Survey of Consumer Finances

This study revisits the empirical question of the determinants of the choice between fixed‐ and adjustable‐rate mortgages using data from the Survey of Consumer Finances that overcome some of the data limitations in previous studies. The results from a logit model of mortgage choice indicate that pricing variables and affordability are important considerations. We also find that factors, such as mobility expectations, income volatility and attitudes toward financial risk largely influence mortgage choice, with more risk‐averse borrowers preferring fixed‐rate mortgages. For households that are less risk averse, the mortgage type choice decision is less sensitive to pricing variables and income volatility, and affordability factors are not significant. These findings provide empirical support that underscores the importance of attitudes toward risks in mortgage choice.

Housing Tenure and Mortgage Choice

This paper examines the relationship between housing tenure and mortgage contract. We present a model showing that, given expected mobility, borrowers will have incentive to self-select into the appropriate mortgage product such that their fixed-rate period is directly related to their probability of moving. We empirically test this hypothesis using housing tenure data derived from a large national database of repeat mortgage transactions. After controlling for borrower characteristics, the mobility hazards of 3/1, 5/1 and 7/1 ARMs, compared to a 30-year fixed rate, are estimated to be 28%, 14% and 11% higher, respectively

Mortgage timing

We study how the term structure of interest rates relates to mortgage choice at both household and aggregate levels. A simple utility framework of mortgage choice points to the long-term bond risk premium as distinct from the yield spread and the long yield as a theoretical determinant of mortgage choice: when the bond risk premium is high, fixed-rate mortgage payments are high, making adjustable-rate mortgages more attractive. We confirm empirically that the bulk of the time variation in both aggregate and loan-level mortgage choice can be explained by time variation in the bond risk premium, whether bond risk premia are measured using forecasters’ data, a vector autoregressive (VAR) term structure model, or a simple household decision rule based on adaptive expectations. The household decision rule moves in lock-step with mortgage choice, lending credibility to a theory of strategic mortgage timing by households.

The loan structure and housing tenure decisions in an equilibrium model of mortgage choice

The objective of this paper is to understand how loan structure affects (i) the borrower's selection of a mortgage contract and (ii) the aggregate economy. We develop a quantitative equilibrium theory of mortgage choice where households can choose from a menu of long-term (nominal) mortgage loans. The model accounts for observed patterns in housing consumption, ownership, and portfolio allocations. We find that the loan structure is a quantitatively significant factor in a household's housing finance decision. The model suggests that the mortgage structure preferred by a household is dependent on age and income and that loan products with low initial payments offer an alternative to mortgages with no downpayment. These effects are more important when inflation is low. The presence of inflation reduces the real value of the mortgage payment and the outstanding loan over time reducing mobility. Changes in the structure of mortgages have implications for risk sharing.

Financial Giffen goods: Examples and counterexamples

Abstract In the basic Markowitz and Merton models, a stock’s weight in efficient portfolios goes up if its expected rate of return goes up. Put differently, there are no financial Giffen goods. By an example from mortgage choice we illustrate that for more complicated portfolio problems Giffen effects do occur.

The Loan Structure and Housing Tenure Decisions in an Equilibrium Model of Mortgage Choice

The objective of this paper is to understand how loan structure affects (i) the borrower's selection of a mortgage contract and (ii) the aggregate economy. We develop a quantitative equilibrium theory of mortgage choice where households can choose from a menu of long-term (nominal) mortgage loans. The model accounts for observed patterns in housing consumption, ownership, and portfolio allocations. We find that the loan structure is a quantitatively significant factor in a household's housing finance decision. The model suggests that the mortgage structure preferred by a household is dependent on age and income and that loan products with low initial payments offer an alternative to mortgages with no downpayment. These effects are more important when inflation is low. The presence of inflation reduces the real value of the mortgage payment and the outstanding loan overtime reducing mobility. Changes in the structure of mortgages have implications for risk sharing.

Mortgage Innovation, Mortgage Choice, and Housing Decisions

This article examines some of the more recent mortgage products now available to borrowers. The authors describe how these products differ across important characteristics, such as the down payment requirement, repayment structure, and amortization schedule.

Mortgage choice and its resulting influence on borrower's styles of living

Mortgage choice and its resulting influence on borrower's styles of living