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Household risk management and actual mortgage choice in the euro area

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  • Ehrmann, Michael
  • Ziegelmeyer, Michael

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 analysed 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 one of 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. JEL Classification: D12, E43, E52, G21

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Bibliographic Info

Paper provided by European Central Bank in its series Working Paper Series with number 1631.

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Date of creation: Jan 2014
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Handle: RePEc:ecb:ecbwps:20141631

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Keywords: adjustable-rate mortgage; fixed-rate mortgage; household finance; monetary policy; mortgage choice;

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  8. John Campbell & Joao F. Cocco, 2002. "Household Risk Management and Optimal Mortgage Choice," Computing in Economics and Finance 2002 47, Society for Computational Economics.
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  17. Matthias Doepke & Martin Schneider, 2006. "Inflation and the Redistribution of Nominal Wealth," Journal of Political Economy, University of Chicago Press, vol. 114(6), pages 1069-1097, December.
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  19. Philomena M. Bacon & Peter G. Moffatt, 2012. "Mortgage Choice as a Natural Field Experiment on Choice under Risk," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 44(7), pages 1401-1426, October.
  20. Gary Solon & Steven J. Haider & Jeffrey Wooldridge, 2013. "What Are We Weighting For?," NBER Working Papers 18859, National Bureau of Economic Research, Inc.
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