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The Interest Rate Elasticity of Mortgage Demand: Evidence From Bunching at the Conforming Loan Limit

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  • DeFusco, Anthony

    () (The Wharton School, University of Pennsylvania)

  • Paciorek, Andrew D.

    () (Board of Governors of the Federal Reserve System (U.S.))

Abstract

The relationship between the mortgage interest rate and a household's demand for mortgage debt has important implications for a host of public policy questions. In this paper, we use detailed data on over 2.7 million mortgages to provide novel estimates of the interest rate elasticity of mortgage demand. Our empirical strategy exploits a discrete jump in interest rates generated by the conforming loan limit--the maximum loan size eligible for securitization by Fannie Mae and Freddie Mac. This discontinuity creates a large ``notch" in the intertemporal budget constraint of prospective mortgage borrowers, allowing us to identify the causal link between interest rates and mortgage demand by measuring the extent to which loan amounts bunch at the conforming limit. Under our preferred specifications, we estimate that a 1 percentage point increase in the rate on a 30-year fixed-rate mortgage reduces first mortgage demand by between 2 and 3 percent. We also present evidence that about one third of the response is driven by borrowers who take out second mortgages while leaving their total mortgage balance unchanged. Accounting for these borrowers suggests a reduction in total mortgage debt of between 1.5 and 2 percent per percentage point increase in the interest rate. Using these estimates, we predict the changes in mortgage demand implied by past and proposed future increases to the guarantee fees charged by Fannie and Freddie. We conclude that these increases would directly reduce the dollar volume of new mortgage originations by well under 1 percent.

Suggested Citation

  • DeFusco, Anthony & Paciorek, Andrew D., 2014. "The Interest Rate Elasticity of Mortgage Demand: Evidence From Bunching at the Conforming Loan Limit," Finance and Economics Discussion Series 2014-11, Board of Governors of the Federal Reserve System (US).
  • Handle: RePEc:fip:fedgfe:2014-11
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    1. repec:eee:ecolet:v:156:y:2017:i:c:p:155-158 is not listed on IDEAS
    2. Baum-Snow, Nathaniel & Ferreira, Fernando, 2015. "Causal Inference in Urban and Regional Economics," Handbook of Regional and Urban Economics, Elsevier.
    3. Anthony A. DeFusco & Andrew Paciorek, 2017. "The Interest Rate Elasticity of Mortgage Demand: Evidence from Bunching at the Conforming Loan Limit," American Economic Journal: Economic Policy, American Economic Association, vol. 9(1), pages 210-240, February.
    4. W. Scott Frame & Andreas Fuster & Joseph Tracy & James Vickery, 2015. "The Rescue of Fannie Mae and Freddie Mac," Journal of Economic Perspectives, American Economic Association, vol. 29(2), pages 25-52, Spring.
    5. Stephanie Johnson & John Mondragon & Anthony DeFusco, 2017. "Regulating Household Leverage," 2017 Meeting Papers 327, Society for Economic Dynamics.
    6. Zhao, Yunhui, 2016. "Got Hurt for What You Paid? Revisiting Government Subsidy in the U.S. Mortgage Market," MPRA Paper 81083, University Library of Munich, Germany, revised 01 Aug 2017.
    7. Agata M. Lozinskaia & Evgeniy M. Ozhegov & Alexander M. Karminsky, 2016. "Discontinuity in Relative Credit Losses: Evidence from Defaults on Government-Insured Residential Mortgages," HSE Working papers WP BRP 55/FE/2016, National Research University Higher School of Economics.
    8. Matteo Benetton, 2017. "Lenders' Competition and Macro-prudential Regulation: A Model of the UK Mortgage Supermarket," 2017 Meeting Papers 1001, Society for Economic Dynamics.
    9. Fuster, Andreas & Zafar, Basit, 2014. "The sensitivity of housing demand to financing conditions: evidence from a survey," Staff Reports 702, Federal Reserve Bank of New York, revised 01 Aug 2015.
    10. Neil Bhutta & Daniel R. Ringo, 2017. "The Effect of Interest Rates on Home Buying : Evidence from a Discontinuity in Mortgage Insurance Premiums," Finance and Economics Discussion Series 2017-086, Board of Governors of the Federal Reserve System (US).
    11. Marco Di Maggio & Amir Kermani & Christopher Palmer, 2016. "How Quantitative Easing Works: Evidence on the Refinancing Channel," NBER Working Papers 22638, National Bureau of Economic Research, Inc.
    12. David Rappoport, 2016. "Do Mortgage Subsidies Help or Hurt Borrowers?," Finance and Economics Discussion Series 2016-081, Board of Governors of the Federal Reserve System (US).
    13. Will Dobbie & Jae Song, 2016. "Debt Relief or Debt Restructuring? Evidence from an Experiment with Distressed Credit Card Borrowers," Working Papers 599, Princeton University, Department of Economics, Industrial Relations Section..

    More about this item

    Keywords

    Mortgage demand; interest rate elasticity; conforming loan limit; bunching;

    JEL classification:

    • D14 - Microeconomics - - Household Behavior - - - Household Saving; Personal Finance
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • R21 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Household Analysis - - - Housing Demand
    • R31 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Real Estate Markets, Spatial Production Analysis, and Firm Location - - - Housing Supply and Markets

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