Interest-Only Mortgages and Consumption Growth: Evidence from a Mortgage Market Reform

Abstract

We use detailed household-level data from Denmark to analyze how the introduction of interest-only mortgages affected consumption expenditure and borrowing. Four years after the reform interest-only mortgages constituted 40 percent of outstanding mortgage debt. Using an ex-ante measure of exposure motivated by financial constraints, we show households who are more likely to use an IO mortgage, increased consumption substantially following the reform. The increase in consumption is driven by borrowing at the time of refinancing and by borrowers with lower pre-reform leverage ratios. Our results show changes in the mortgage contract can have large impacts on consumption expenditure.

Temptation and Incentives to Wealth Accumulation

“…Bernstein and Koudijs (2020) study the introduction of a mandatory amortization policy in the Netherlands and find that amortization payments result in a near one-for-one increase in net wealth accumulation, as households increase their housing wealth but do not reduce their liquid assets. In addition, Bäckman and Khorunzhina (2020) study the elimination of mandatory amortization in Denmark (the opposite of the policy in the Netherlands) and find that the elimination of mandatory amortization results in a large increase in consumption, which implies lower saving rates.…”

Optimal refinancing strategy for mortgage rate with regime switching

“…An interest‐only (IO) mortgage loan requires the borrower to only make interest payments over the term of the loan and repay the entire principal at the end of the loan term 1 . As described in Bäckman and Khorunzhina, 2 interest‐only mortgages account for half of all outstanding mortgage contracts in the United States in 2007. Using the empirical analysis based on the data from Denmark Statistics, they found IO mortgages have a significant impact on household consumption and borrowing.…”