Equilibrium Mortgage Choice and Housing Tenure Decisions with Refinancing

Matthew S. Chambers, Carlos Garriga, and Don Schlagenhauf
Working Paper 2007-25
December 2007

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The last decade has brought about substantial mortgage innovation and increased refinancing. The objective of this paper is to understand the determinants and implications of mortgage choice in the context of a general equilibrium model with incomplete markets. The equilibrium characterization allows us to study the impact of mortgage financing decisions in the productive economy. We show the influence of different contract characteristics such as the down payment requirement, repayment structure, and the amortization schedule for mortgage choice. We find that loan products that allow for low or no down payment or an increasing repayment schedule increase the participation of young and lower-income households. We find evidence that the volume of housing transactions increases when the payment profile is increasing and households have little housing equity. In contrast, we show that loans that allow for a rapid accumulation of home equity can still have positive participation effects without increasing the volatility of the housing market. The model predicts that the expansion of mortgage contracts and refinancing improves risk sharing opportunities for homeowners, but the magnitude varies with each contract.

JEL classification: E0, D58, D91, R21

Key words: macroeconomics, housing, mortgages

The authors acknowledge useful comments from Michele Boldrin, Suparna Chakrohorty, Martin Gervais, Karsten Jeske, Monika Piazzesi, Martin Schneider, Kjetil Storesletten, Eric Young, two anonymous referees, and participants at the conference on housing, mortgage finance, and the macroeconomy held at the Federal Reserve Bank of Atlanta. Michele Armesto provided useful assistance. We are grateful to the financial support of the National Science Foundation for grant no. SES-0649374. Carlos Garriga also acknowledges support from the Spanish Ministerio de Ciencia y Tecnologia through grant no. SEJ2006-02879. The views expressed here are the authors' and not necessarily those of the Federal Reserve Banks of Atlanta or St. Louis or the Federal Reserve System. Any remaining errors are the authors' responsibility.

Please address questions regarding content to Don Schlagenhauf, Department of Economics, Florida State University, 246 Bellamy Building, Tallahassee, FL 32306-2180, dschlage@fsu.edu, and Visiting Scholar, Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street, N.E., Atlanta, GA 30309-4470; Matthew S. Chambers, Department of Economics, Towson University, 8000 York Road, Towson, MD 21252; or Carlos Garriga, Research Division, Federal Reserve Bank of St. Louis, P.O. Box 442, St. Louis, MO 63166.

For further information, contact the Public Affairs Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street, N.E., Atlanta, Georgia 30309-4470, 404-498-8020.