The myopic choice between fixed and adjustable rate mortgages in Flanders

Sven Damen and Erik Buyst

Working Papers of Department of Economics, Leuven from KU Leuven, Faculty of Economics and Business (FEB), Department of Economics, Leuven

Abstract: Many households have only one major asset, a house, which is usually financed through a mortgage contract. One of the most important financial decisions a household has to make is therefore the choice of mortgage type. These can be broadly described as falling into one of two categories: the fixed rate mortgage (FRM) and the adjustable rate mortgage (ARM). We use data from Flanders (Belgium) to study the choice between FRMs and ARMs. Belgium is of special interest as the structure of the Belgian mortgage market varied significantly during the last decade. From 2003 to 2012, the Belgian share of mortgages with an initial rate fixation period up to one year fell from 62% in 2004 to 8% in 2006, recovered to 58% in 2010, and fell again to 5% in 2012. This is a remarkably large variation in comparison to other countries. The results indicate that the FRM-ARM interest rate spread explains almost all the variation of the ARM share from 2003:01 to 2012:12. However, households do not distinguish between changes in the premium that lenders demand for holding the riskier long-term FRM or expected changes in the ARM rate. Mortgage choices can thus be described as short-sighted decisions, based on initial mortgage payments. We furthermore find evidence that high and low income households in Flanders choose an ARM for different reasons. Whereas the high income segment chooses an ARM if they can afford changes in interest payments, the low income households prefer an ARM if they are financially constrained.

Date: 2013-09
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