IDEAS home Printed from https://ideas.repec.org/a/eee/soceco/v107y2023ics2214804323001301.html
   My bibliography  Save this article

The role of borrower expectations in mortgage choice

Author

Listed:
  • Devine, Kenneth
  • McCarthy, Yvonne
  • O’Toole, Conor

Abstract

This paper analyses the role of interest rate expectations in determining a household’s selection of mortgage product. We use a bespoke survey of 2,003 mortgage holders conducted by the Central Bank of Ireland to investigate the choice between safe fixed-rate and risky adjustable rate products. Our empirical methodology adopts a probit model to estimate the effect of a series of household characteristics, behavioural influences and mortgage criteria on product selection. This research provides novel insights into the determinants of mortgage choice, as our study is the first in the literature to explore expectations utilising a new measurement technique. Our results indicate that while pricing matters, future interest rate expectations are a key motivating factor in the mortgage choice decision. In addition to this, we investigate the accuracy of expectations and find higher levels of education and financial knowledge increase the probability of correct predictions.

Suggested Citation

  • Devine, Kenneth & McCarthy, Yvonne & O’Toole, Conor, 2023. "The role of borrower expectations in mortgage choice," Journal of Behavioral and Experimental Economics (formerly The Journal of Socio-Economics), Elsevier, vol. 107(C).
    • Handle: RePEc:eee:soceco:v:107:y:2023:i:c:s2214804323001301
    DOI: 10.1016/j.socec.2023.102104
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S2214804323001301
    Download Restriction: Full text for ScienceDirect subscribers only
    File URL: https://libkey.io/10.1016/j.socec.2023.102104?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    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. John Y. Campbell & João F. Cocco, 2003. "Household Risk Management and Optimal Mortgage Choice," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 118(4), pages 1449-1494.
    3. Pesaran, M. Hashem & Weale, Martin, 2006. "Survey Expectations," Handbook of Economic Forecasting, in: G. Elliott & C. Granger & A. Timmermann (ed.), Handbook of Economic Forecasting, edition 1, volume 1, chapter 14, pages 715-776, Elsevier.
    4. John Y. Campbell & Howell E. Jackson & Brigitte C. Madrian & Peter Tufano, 2011. "Consumer Financial Protection," Journal of Economic Perspectives, American Economic Association, vol. 25(1), pages 91-114, Winter.
    5. van Rooij, Maarten & Lusardi, Annamaria & Alessie, Rob, 2011. "Financial literacy and stock market participation," Journal of Financial Economics, Elsevier, vol. 101(2), pages 449-472, August.
    6. Thomas Dohmen & Armin Falk & David Huffman & Uwe Sunde & Jürgen Schupp & Gert G. Wagner, 2011. "Individual Risk Attitudes: Measurement, Determinants, And Behavioral Consequences," Journal of the European Economic Association, European Economic Association, vol. 9(3), pages 522-550, June.
    7. Lusardi, Annamaria & Tufano, Peter, 2015. "Debt literacy, financial experiences, and overindebtedness," Journal of Pension Economics and Finance, Cambridge University Press, vol. 14(4), pages 332-368, October.
    8. Cristian Badarinza & John Y. Campbell & Tarun Ramadorai, 2018. "What Calls to ARMs? International Evidence on Interest Rates and the Choice of Adjustable-Rate Mortgages," Management Science, INFORMS, vol. 64(5), pages 2275-2288, May.
    9. Itzhak Ben-David & Elyas Fermand & Camelia M. Kuhnen & Geng Li, 2018. "Expectations Uncertainty and Household Economic Behavior," NBER Working Papers 25336, National Bureau of Economic Research, Inc.
    10. Monica Paiella & Alberto Franco Pozzolo, 2007. "Choosing between Fixed- and Adjustable-Rate Mortgages," Palgrave Macmillan Books, in: Sumit Agarwal & Brent W. Ambrose (ed.), Household Credit Usage, chapter 0, pages 219-236, Palgrave Macmillan.
    11. Sumit Agarwal & John C. Driscoll & Xavier Gabaix & David Laibson, 2009. "The Age of Reason: Financial Decisions over the Life Cycle and Implications for Regulation," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 40(2 (Fall)), pages 51-117.
    12. Bucks, Brian & Pence, Karen, 2008. "Do borrowers know their mortgage terms?," Journal of Urban Economics, Elsevier, vol. 64(2), pages 218-233, September.
    13. 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, December.
    14. McElligott, Rory, 2007. "Irish Retail Interest Rates - Why do they differ from the rest of Europe?," Quarterly Bulletin Articles, Central Bank of Ireland, pages 137-152, January.
    15. Gathergood, John & Weber, Jörg, 2017. "Financial literacy, present bias and alternative mortgage products," Journal of Banking & Finance, Elsevier, vol. 78(C), pages 58-83.
    16. David Leece, 2000. "Household Choice of Fixed Versus Floating Rate Debt: A Binomial Probit Model With Correction For Classification Error," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 62(1), pages 61-82, February.
    17. Basit Zafar, 2011. "Can subjective expectations data be used in choice models? evidence on cognitive biases," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 26(3), pages 520-544, April.
    18. Ruben Cox & Dirk Brounen & Peter Neuteboom, 2015. "Financial Literacy, Risk Aversion and Choice of Mortgage Type by Households," The Journal of Real Estate Finance and Economics, Springer, vol. 50(1), pages 74-112, January.
    19. Doyle, Nicola, 2009. "Housing Finance Developments in Ireland," Quarterly Bulletin Articles, Central Bank of Ireland, pages 75-88, October.
    20. 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.
    21. Christopher D. Carroll, 2003. "Macroeconomic Expectations of Households and Professional Forecasters," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 118(1), pages 269-298.
    22. Masaki Mori & Julian Diaz III & Alan J. Ziobrowski, 2009. "Why Do Borrowers Choose Adjustable-Rate Mortgages over Fixed-Rate Mortgages? : A Behavioral Investigation," International Real Estate Review, Global Social Science Institute, vol. 12(2), pages 98-120.
    23. Ehrmann, Michael & Ziegelmeyer, Michael, 2014. "Household Risk Management and Actual Mortgage Choice in the Euro Area," MEA discussion paper series 201406, Munich Center for the Economics of Aging (MEA) at the Max Planck Institute for Social Law and Social Policy.
    24. Michael King & Anuj Singh, 2018. "Conned by a Cashback? Disclosure, Nudges and Consumer Rationality in Mortgage Choice," Trinity Economics Papers tep1118, Trinity College Dublin, Department of Economics.
    25. Köhler-Ulbrich, Petra & Asimakopoulos, Yannis & Doyle, Nicola & Magono, Ruth & Zachary, Marie-Denise & Walko, Zoltan & Stoess, Elmar & Kok, Christoffer & Wagner, Karin & Valckx, Nico & Martínez Pagés,, 2009. "Housing finance in the euro area," Occasional Paper Series 101, European Central Bank.
    26. Michael LaCour‐Little & Jing Yang, 2010. "Pay Me Now or Pay Me Later: Alternative Mortgage Products and the Mortgage Crisis," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 38(4), pages 687-732, Winter.
    27. Charles F. Manski, 2004. "Measuring Expectations," Econometrica, Econometric Society, vol. 72(5), pages 1329-1376, September.
    28. Laibson, David I. & Agarwal, Sumit & Driscoll, John C. & Gabaix, Xavier, 2009. "The Age of Reason: Financial Decisions over the Life-Cycle with Implications for Regulation," Scholarly Articles 4554335, Harvard University Department of Economics.
    29. Lusardi, Annamaria & Mitchell, Olivia S., 2011. "Financial literacy around the world: an overview," Journal of Pension Economics and Finance, Cambridge University Press, vol. 10(4), pages 497-508, October.
    30. Donkers, Bas & van Soest, Arthur, 1999. "Subjective measures of household preferences and financial decisions," Journal of Economic Psychology, Elsevier, vol. 20(6), pages 613-642, December.
    31. D. Duffy & M.J. Roche, 2005. "Heterogeneous Homebuyers, Mortgage Choice and the use of Mortgage Brokers," Economics Department Working Paper Series n1520205, Department of Economics, National University of Ireland - Maynooth.
    32. John Krainer, 2010. "Mortgage choice and the pricing of fixed-rate and adjustable-rate mortgages," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue feb1.
    33. Robert B. Barsky & F. Thomas Juster & Miles S. Kimball & Matthew D. Shapiro, 1997. "Preference Parameters and Behavioral Heterogeneity: An Experimental Approach in the Health and Retirement Study," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 112(2), pages 537-579.
    34. Michelle Norris & Dermot Coates, 2014. "How housing killed the Celtic tiger: anatomy and consequences of Ireland's housing boom and bust," Open Access publications 10197/5639, Research Repository, University College Dublin.
    35. Hendershott, Patric H. & LaFayette, William C. & Haurin, Donald R., 1997. "Debt Usage and Mortgage Choice: The FHA-Conventional Decision," Journal of Urban Economics, Elsevier, vol. 41(2), pages 202-217, March.
    36. 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.
    37. repec:mea:meawpa:14283 is not listed on IDEAS
    38. Hemert, Otto van & Jong, Franck de & Driessen, Joost, 2005. "Dynamic portfolio and mortgage choice for homeowners," LSE Research Online Documents on Economics 24650, London School of Economics and Political Science, LSE Library.
    39. Francesco Drudi & Petra Köhler-Ulbrich & Marco Protopapa & Jiri Slacalek & Christoffer Kok Sørensen & Guido Wolswijk & Ramón Gómez Salvador & Ruth Magono & Nico Valckx & Elmar Stöss & Gerbert Hebbink , 2009. "Housing Finance in the Euro Area," Occasional Paper Series 101, European Central Bank.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Scott, David & Pratap Singh, Anuj, 2024. "Mortgage switching through the turning of the interest rate cycle," Financial Stability Notes 2/FS/24, Central Bank of Ireland.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Dancsik, Bálint, 2017. "Számít-e a devizahiteles múlt?. A lakáshitelkamatok rögzítéséről szóló döntés vizsgálata mikroszintű adatokon [Analysing the decision of fixing housing loan interest rates on micro-level data: does," Közgazdasági Szemle (Economic Review - monthly of the Hungarian Academy of Sciences), Közgazdasági Szemle Alapítvány (Economic Review Foundation), vol. 0(10), pages 1030-1055.
    2. Dungey, Mardi & Doko Tchatoka, Firmin & Yanotti, María B., 2018. "Endogeneity in household mortgage choice," Economic Modelling, Elsevier, vol. 73(C), pages 30-44.
    3. Guiso, Luigi & Sodini, Paolo, 2013. "Household Finance: An Emerging Field," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, volume 2, chapter 0, pages 1397-1532, Elsevier.
    4. van Ooijen, Raun & van Rooij, Maarten C.J., 2016. "Mortgage risks, debt literacy and financial advice," Journal of Banking & Finance, Elsevier, vol. 72(C), pages 201-217.
    5. Francisco Gomes & Michael Haliassos & Tarun Ramadorai, 2021. "Household Finance," Journal of Economic Literature, American Economic Association, vol. 59(3), pages 919-1000, September.
    6. Gathergood, John & Weber, Jörg, 2017. "Financial literacy, present bias and alternative mortgage products," Journal of Banking & Finance, Elsevier, vol. 78(C), pages 58-83.
    7. Guiso, Luigi & Pozzi, Andrea & Tsoy, Anton & Gambacorta, Leonardo & Mistrulli, Paolo Emilio, 2022. "The cost of steering in financial markets: Evidence from the mortgage market," Journal of Financial Economics, Elsevier, vol. 143(3), pages 1209-1226.
    8. Almenberg, Johan & Dreber, Anna, 2015. "Gender, stock market participation and financial literacy," Economics Letters, Elsevier, vol. 137(C), pages 140-142.
    9. Michael Ehrmann & Michael Ziegelmeyer, 2017. "Mortgage Choice in the Euro Area: Macroeconomic Determinants and the Effect of Monetary Policy on Debt Burdens," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 49(2-3), pages 469-494, March.
    10. Ruben Cox & Dirk Brounen & Peter Neuteboom, 2015. "Financial Literacy, Risk Aversion and Choice of Mortgage Type by Households," The Journal of Real Estate Finance and Economics, Springer, vol. 50(1), pages 74-112, January.
    11. Azra Zaimovic & Anes Torlakovic & Almira Arnaut-Berilo & Tarik Zaimovic & Lejla Dedovic & Minela Nuhic Meskovic, 2023. "Mapping Financial Literacy: A Systematic Literature Review of Determinants and Recent Trends," Sustainability, MDPI, vol. 15(12), pages 1-30, June.
    12. Malmendier, Ulrike M. & Botsch, Matthew J., 2020. "The Long Shadows of the Great Inflation: Evidence from Residential Mortgages," CEPR Discussion Papers 14934, C.E.P.R. Discussion Papers.
    13. Kadoya, Yoshihiko & Khan, Mostafa Saidur Rahim, 2020. "What determines financial literacy in Japan?," Journal of Pension Economics and Finance, Cambridge University Press, vol. 19(3), pages 353-371, July.
    14. 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.
    15. Ehrmann, Michael & Ziegelmeyer, Michael, 2014. "Household Risk Management and Actual Mortgage Choice in the Euro Area," MEA discussion paper series 201406, Munich Center for the Economics of Aging (MEA) at the Max Planck Institute for Social Law and Social Policy.
    16. Elsa Fornero & Chiara Monticone & Serena Trucchi, 2011. "The effect of financial literacy on mortgage choices," CeRP Working Papers 121, Center for Research on Pensions and Welfare Policies, Turin (Italy).
    17. Lunn, Pete & McGowan, Féidhlim & Howard, Noel, 2018. "Do some financial product features negatively affect consumer decisions? a review of evidence," Research Series, Economic and Social Research Institute (ESRI), number RS78, August.
    18. repec:mea:meawpa:14283 is not listed on IDEAS
    19. Cristian Badarinza & John Y. Campbell & Tarun Ramadorai, 2018. "What Calls to ARMs? International Evidence on Interest Rates and the Choice of Adjustable-Rate Mortgages," Management Science, INFORMS, vol. 64(5), pages 2275-2288, May.
    20. Duca, John V. & Kumar, Anil, 2014. "Financial literacy and mortgage equity withdrawals," Journal of Urban Economics, Elsevier, vol. 80(C), pages 62-75.
    21. Kawamura, Tetsuya & Mori, Tomoharu & Motonishi, Taizo & Ogawa, Kazuhito, 2021. "Is Financial Literacy Dangerous? Financial Literacy, Behavioral Factors, and Financial Choices of Households," Journal of the Japanese and International Economies, Elsevier, vol. 60(C).

    More about this item

    Keywords

    Mortgages; Household finance; Expectations;
    All these keywords.

    JEL classification:

    • D10 - Microeconomics - - Household Behavior - - - General
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:soceco:v:107:y:2023:i:c:s2214804323001301. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/inca/620175 .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.