DP10117 What Calls to ARMs? International Evidence on Interest Rates and the Choice of Adjustable Rate Mortgages

Author(s): Cristian Badarinza, John Y Campbell, Tarun Ramadorai
Publication Date: August 2014
Keyword(s): adjustable-rate, fixed-rate, household finance, interest rate, international, mortgage choice
JEL(s): G21, N20, R21, R31
Programme Areas: International Macroeconomics, Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=10117

The relative popularity of adjustable-rate mortgages (ARMs) and fixed-rate mortgages (FRMs) varies considerably both across countries and over time. We ask how movements in current and expected future interest rates affect the share of ARMs in total mortgage issuance. Using a nine-country panel and instrumental variables methods, we present evidence that near-term (one-year) rational expectations of future movements in ARM rates do affect mortgage choice, particularly in more recent data since 2001. However longer-term (three-year) rational forecasts of ARM rates have a weaker effect, and the current spread between FRM and ARM rates also matters, suggesting that households are concerned with current interest costs as well as with lifetime cost minimization. These conclusions are robust to alternative (adaptive and survey-based) models of household expectations.