SUMIT AGARWAL, National University of Singapore
Email: ushakri@yahoo.com
RICHARD J. ROSEN, Federal Reserve Bank of Chicago - Economic Research
Email: rrosen@frbchi.org
VINCENT YAO, Federal National Mortgage Association (Fannie Mae)
Email: vincent_yao@fanniemae.com

Refinancing a mortgage is often one of the biggest and most important financial decisions that people make. Borrowers need to choose the interest rate differential at which to refinance and, when that differential is reached, they need to take the steps to refinance before rates change again. The optimal differential is where the interest saved by refinancing equals the sum of refinancing costs and the option value of refinancing. Using a unique panel data set, we find that approximately 59% of borrowers refinance sub-optimally – with 52% of the sample making errors of commission (choosing the wrong rate), 17% making errors of omission (waiting too long to refinance), and 10% making both errors. Financially sophisticated borrowers make smaller mistakes, refinancing at rates closer to the optimal rate and waiting less after mortgage rates reach the borrowers’ trigger rates. Evidence suggests borrowers learn from their refinancing experiences as they make smaller mistakes on their second refinancing than on their first one.

PATRICK J. BAYER, Duke University - Department of Economics, National Bureau of Economic Research (NBER)
Email: patrick.bayer@duke.edu
FERNANDO V. FERREIRA, University of Pennsylvania - The Wharton School
Email: fferreir@wharton.upenn.edu
STEPHEN L. ROSS, University of Connecticut - Department of Economics
Email: ROSS@SP.UCONN.EDU

This paper examines mortgage outcomes for a large, representative sample of individual home purchases and refinances linked to credit scores in seven major US markets in the recent housing boom and bust. Among those with similar credit scores, black and Hispanic homeowners had much higher rates of delinquency and default in the downturn. These differences are not readily explained by the likelihood of receiving a subprime loan or by differential exposure to local shocks in the housing and labor market and are especially pronounced for loans originated near the peak of the boom. Our findings suggest that those black and Hispanic homeowners drawn into the market near the peak were especially vulnerable to adverse economic shocks and raise serious concerns about homeownership as a mechanism for reducing racial disparities in wealth.

PAOLO GELAIN, Norges Bank
Email: Paolo.Gelain@Norges-Bank.no
KEVIN J. LANSING, Federal Reserve Bank of San Francisco, Norges Bank
Email: kevin.j.lansing@sf.frb.org
CATERINA MENDICINO, Bank of Portugal
Email: caterina.mendicino@bportugal.pt

Progress on the question of whether policymakers should respond directly to financial variables requires a realistic economic model that captures the links between asset prices, credit expansion, and real economic activity. Standard DSGE models with fully-rational expectations have difficulty producing large swings in house prices and household debt thatresemble the patterns observed in many developed countries over the past decade. We introduce excess volatility into an otherwise standard DSGE model by allowing a fraction of households to depart from fully-rational expectations. Specifically, we show that theintroduction of simple moving-average forecast rules for a subset of households can significantly magnify the volatility and persistence of house prices and household debt relative to otherwise similar model with fully-rational expectations. We evaluate various policy actions that might be used to dampen the resulting excess volatility, including a direct response to house price growth or credit growth in the central bank's interest rate rule, the imposition of more restrictive loan-to-value ratios, and the use of a modified collateral constraint that takes into account the borrower's loan-to-income ratio. Of these, we find that a loan-to-income constraint is the most effective tool for dampening overall excess volatility in the model economy. We find that while an interest-rate response to house price growth or credit growth can stabilize some economic variables, it can significantly magnify the volatility of others, particularly inflation.

C. M. VAN HEERDEN, University of Pretoria
Email: corlia.vanheerden@up.ac.za

A natural person consumer who enters into a mortgage agreement with a credit provider-mortgagee enjoys significant protection under the National credit Act (NCA). This protection is not only of a substantive nature such as capping of interest rates, but entails elaborate procedural compliance by a credit provider who wishes to enforce a mortgage agreement. As such the NCA requires compliance with certain pre-enforcement procedures and also requires that further procedural requirements be met when the matter serves before court. It is submitted that further procedural protection is also afforded to a consumer by virtue of section 130(4) which sets out specific powers of a court when it adjudicates a credit agreement matter. In addition to the extensive procedural protection afforded to a natural person mortgagor by the NCA, the Act also provides extensive debt relief remedies to distressed natural person consumers who are over-indebted and/or to whom reckless credit has been extended. These remedies also bring with them another layer of significant procedural compliance to be observed by credit grantors. Where successfully applied for, these debt relief remedies may have a variety of alleviating consequences, ranging from a temporary moratorium on debt enforcement, to debt restructuring and /or suspension, to partial or complete setting aside of the rights and obligations of the consumer.