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Household Risk Management and Actual Mortgage Choice in the Euro Area

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  • Michael Ehrmann
  • Michael Ziegelmeyer

Abstract

Mortgages constitute the largest part of household debt. An essential choice when taking out a mortgage is between fixed-interest-rate mortgages (FRMs) and adjustable-interest-rate mortgages (ARMs). However, so far, no comprehensive cross-country study has analyzed what determines household demand for mortgage types, a task that this paper takes up using new data for the euro area. Our results support the hypothesis of Campbell and Cocco (2003) that the decision is best described as household risk management: income volatility reduces the take-out of ARMs, while increasing duration and relative size of the mortgages increase it. Controlling for other supply factors through country fixed effects, loan pricing also matters, as expected, with ARMs becoming more attractive when yield spreads rise. The paper also conducts a simulation exercise to identify how the easing of monetary policy during the financial crisis affected mortgage holders. It shows that the resulting reduction in mortgage rates produced a substantial decline in debt burdens among mortgage-holding households, especially in countries where households have higher debt burdens and a larger share of ARMs, as well as for some disadvantaged groups of households, such as those with low income.

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Bibliographic Info

Paper provided by Bank of Canada in its series Working Papers with number 14-1.

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Length: 39 pages
Date of creation: 2014
Date of revision:
Handle: RePEc:bca:bocawp:14-1

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Keywords: Credit and credit aggregates; Transmission of monetary policy;

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