With the development of increasingly complex mortgage instruments, the process by which consumers choose among these instruments also increases in importance. The real estate literature does not address how consumers of mortgage instruments make trade-offs among the different instruments. The study controlled for interest rates, and looked at five variables: number of points, additional fees, reputation of lender, type of mortgage (FRM vs. ARM), and term in years of mortgage. Using conjoint analysis it is found that consumers do indeed have different preferences for different mixes of mortgage instruments. It is suggested that mortgage instruments can be tailored to different market segments of borrowers.
Regulators in the UK and the USA recognize the need to assist borrowers that face a huge number of mortgage products with a multitude of fee combinations offered by a large number of lenders. For over 25 years they attempted to make the mortgage selection process more borrower‐friendly but, for many reasons, the efficacy of the chosen comparison tool, the Annual Percentage Rate (APR), is questionable. Because many consumers are either unwilling or unable to make price comparisons between mortgages based on the APR, we suggest replacing the APR with a new measure called the Annual Effective Rate (AER). The AER is based on the actual length of time the borrower expects to maintain the loan and the assumption that all up‐front loan costs are financed. In addition, we suggest that this comparison rate only be presented for true fixed‐rate loans and that all up‐front cost categories that are used in computing the AER be standardized.
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