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

Author

Listed:
  • Furlong, Frederick T.

    () (Federal Reserve Bank of San Francisco)

  • Takhtamanova, Yelena

    () (Federal Reserve Bank of San Francisco)

  • Lang, David

    () (Federal Reserve Bank of San Francisco)

Abstract

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.

Suggested Citation

  • Furlong, Frederick T. & Takhtamanova, Yelena & Lang, David, 2014. "Mortgage Choice in the Housing Boom: Impacts of House Price Appreciation and Borrower Type," Working Paper Series 2014-5, Federal Reserve Bank of San Francisco, revised Mar 2014.
  • Handle: RePEc:fip:fedfwp:2014-05
    DOI: 10.24148/wp2014-05
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    References listed on IDEAS

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    1. Dhillon, Upinder S & Shilling, James D & Sirmans, C F, 1987. "Choosing between Fixed and Adjustable Rate Mortgages: A Note," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 19(2), pages 260-267, May.
    2. Brahima Coulibaly & Geng Li, 2009. "Choice of Mortgage Contracts: Evidence from the Survey of Consumer Finances," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 37(4), pages 659-673.
    3. Bucks, Brian & Pence, Karen, 2008. "Do borrowers know their mortgage terms?," Journal of Urban Economics, Elsevier, vol. 64(2), pages 218-233, September.
    4. James Vickery, 2007. "Interest rates and consumer choice in the residential mortgage market: a summary," Proceedings 1041, Federal Reserve Bank of Chicago.
    5. William C. Wheaton & Gleb Nechayev, 2008. "The 1998 ?2005 Housing "Bubble" and the Current "Correction": What’s Different This Time?," Journal of Real Estate Research, American Real Estate Society, vol. 30(1), pages 1-26.
    6. Statman, Meir, 1982. "Fixed Rate or Index-Linked Mortgages from the Borrower's Point of View: A Note," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 17(03), pages 451-457, September.
    7. Nothaft, Frank E & Wang, George H K, 1992. "Determinants of the ARM Share of National and Regional Lending," The Journal of Real Estate Finance and Economics, Springer, vol. 5(2), pages 219-234, June.
    8. Brueckner, Jan K & Follain, James R, 1988. "The Rise and Fall of the ARM: An Econometric Analysis of Mortgage Choice," The Review of Economics and Statistics, MIT Press, vol. 70(1), pages 93-102, February.
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    Cited by:

    1. Michael Richter, 2017. "Asymmetric Effects on Financial Cycles in a Monetary Union with Diverging Country Preferences for Variable- and Fixed-Rate Mortgages," Review of Economics & Finance, Better Advances Press, Canada, vol. 7, pages 19-36, February.

    More about this item

    Keywords

    mortgage choice; mortgage contracts; household finance; fixed-rate; adjustable-rate;

    JEL classification:

    • D1 - Microeconomics - - Household Behavior
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • R2 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Household Analysis

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