Fixed‐Rate Mortgages, Labor Markets, and Efficiency

Abstract

The paper studies the effects of mortgage choices between fixed‐rate mortgages (FRMs) and adjustable‐rate mortgages (ARMs) on labor market efficiency. FRMs provide insurance for risk‐averse borrowers in the sense that they pay the same rate over time and are not subject to uncertain spot market rates. FRMs, however, discourage borrowers from moving to other regions despite better employment opportunities, as they terminate the FRM contracts in order to move and their new loan interests may be higher. As FRM‐borrowers do not move to other regions due to the interest lock‐ins, entrepreneurs in other regions lose the potential surpluses from productive matches that would have occurred between borrowers‐workers and entrepreneurs. Borrowers ignore this negative externality they impose on the entrepreneurs when choosing their mortgages, and too many borrowers choose FRMs relative to the efficient level. If FRMs are eliminated and ARM‐insurance (that protects ARM‐borrowers against uncertain adjustable interest rates) is created, it will improve efficiency. The paper also assesses quantitatively the welfare effects of eliminating FRMs and providing ARM‐insurance.

Optimal Sharing of Interest‐Rate Risk in Mortgage Contracts: The Effects of Potential Prepayment and Default

“…The analysis focuses next on prepayment due to job relocation, building on the work of Lee (), who identified an inefficient type of mortgage‐related “lock‐in” that differs from the usual mobility friction due to negative housing equity (see Chan , Engelhardt , Ferreira, Gyourko and Tracy ). In particular, Lee argued (building on evidence from Quigley ) that existing FRM borrowers, who are protected from high interest rates during boom times, may turn down favorable job relocation opportunities that arise in such times in order to avoid forsaking their advantageous loan rate (which would happen following a move and reentry into the mortgage market).…”

The Economics of Internal Migration: Advances and Policy Questions

“…Another mortgage-related friction is that borrowers with fixed-rate mortgages face an increase in borrowing costs if the currently offered mortgage rate is higher than the rate on the borrower's current mortgage. Lee (2018) develops a model in which borrowers with a fixed-rate mortgage are locked in, while those with an adjustable rate are not; switching everyone to adjustable-rate mortgages increases migration. Empirically, Ferreira et al (2010) find that mortgage rate lock-in reduces migration.…”

Optimal Risk-Sharing in Mortgage Contracts: The Effects of Potential Prepayment and Default

“…The analysis focuses next on prepayment due to job relocation, building on the work of Lee (2014), who identified an inefficient type of mortgage-related "lock-in" that differs from the usual mobility friction due to negative housing equity (see Chan (2001), Engelhardt (2003), and Ferreira, Gyourko and Tracy (2010)). In particular, Lee argued that existing FRM borrowers, who are protected from high interest rates during boom times, may turn down favorable job relocation opportunities that arise in such times in order to avoid forsaking their advantageous loan rate (which would happen following a move and reentry into the mortgage market).…”