Choosing Between Fixed and Adjustable Rate Mortgages

Monica Paiella and Alberto Pozzolo

Economics & Statistics Discussion Papers from University of Molise, Department of Economics

Abstract: This paper estimates the determinants of households’ choice between fixed rate (FRM) and adjustable rate mortgage (ARM) contracts, using the Bank of Italy’s Survey of Household Income and Wealth. Contrary to the predictions of the theoretical literature, the analysis shows that most household characteristics proxying for exposure to other (non-mortgagerelated) risks and for individual risk aversion are irrelevant for the choice. This, in turn, crucially depends on the relative price of the mortgages and on whether the household is liquidity constrained. Liquidity constrained households find ARMs particularly attractive because their initial payments are generally lowest, ceteris paribus. This is so despite some evidence that the premium that lenders charge over their cost of funds is substantially higher on ARMs than on FRMs. Taken together, the evidence suggests that ARM holders do not fully take into account the risk of a rise of the reference interest rates. On the other hand, lenders price quite expensively this risk and borrowers end up paying a high price for the benefit of low initial payments.

Keywords: home purchase finance; adjustable rate mortgages; fixed rate mortgages. (search for similar items in EconPapers)
JEL-codes: D10 E4 G1 G21 (search for similar items in EconPapers)
Pages: 41 pages
Date: 2007-04-10
New Economics Papers: this item is included in nep-ban and nep-ure
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (18)

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Related works:
Chapter: Choosing between Fixed- and Adjustable-Rate Mortgages (2007)
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Persistent link: https://EconPapers.repec.org/RePEc:mol:ecsdps:esdp07033

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