March 08, 2017

What is the Microelasticity of Mortgage Demand to Interest Rates?

Stephanie H. Lo

What is the microelasticity of mortgage demand to interest rates? Despite the importance of this parameter for models of monetary policy efficacy, little is known about the intensive and extensive margins of mortgage demand to interest rates. I propose an identification strategy using novel microdata on mortgage rates. I exploit the fact that, due to regulatory factors, spreads in mortgage rates across borrowers exhibit a cutoff at certain FICO scores, and show using default and securitization data that a regression discontinuity design across mortgage pricing breakpoints isolates demand, not supply, margins. I show that the intensive and extensive margins of demand for mortgages are sensitive to interest rates and are economically large: a 25 basis point decrease in mortgage rates for high-FICO individuals is associated with a 50% increase in the likelihood of a potential borrower to demand a loan and an increase in loan size of approximately $15k, or approximately 10% of the average origination volume. I additionally find that for both the intensive and extensive margin, borrowers with high FICOs tend to be more sensitive to interest rate changes, elasticities are relatively constant over time, and the marginal responsiveness to interest rates is decreasing.

Category: Working Papers

Read More About: Housing Markets & Conditions