Why Were Interest-only Mortgages so Popular During the U.S. Housing Boom?

66 Pages Posted: 22 Nov 2010 Last revised: 28 May 2020

See all articles by Gadi Barlevy

Gadi Barlevy

Federal Reserve Bank of Chicago; National Bureau of Economic Research (NBER); IZA Institute of Labor Economics

Jonas D. M. Fisher

Federal Reserve Bank of Chicago - Economic Research Department

Date Written: July 1, 2011

Abstract

Borrowers in U.S. cities where house prices boomed in the 2000s relied heavily on backloaded interest-only (IO) mortgages that require borrowers to only pay interest for the first few years of the loan. We develop a theory that encompasses common explanations for IO use, and show that while they can account for much of the regional variation in IOs, they cannot explain why IOs were popular in boom cities. We propose a new explanation. In our model, uncertain price appreciation coupled with non-recourse lending can lead to speculation financed with backloaded mortgages. We find evidence that IO borrowers behaved in ways consistent with such speculation, and discuss the policy implications of our findings.

Keywords: Housing, house prices, interest-only mortgages, speculation, bubble

JEL Classification: E0, O4, R0

Suggested Citation

Barlevy, Gadi and Fisher, Jonas D. M., Why Were Interest-only Mortgages so Popular During the U.S. Housing Boom? (July 1, 2011). FRB of Chicago Working Paper No. 2010-12, Available at SSRN: https://ssrn.com/abstract=1713308 or http://dx.doi.org/10.2139/ssrn.1713308

Gadi Barlevy (Contact Author)

Federal Reserve Bank of Chicago ( email )

230 South LaSalle Street
Chicago, IL 60604
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Jonas D. M. Fisher

Federal Reserve Bank of Chicago - Economic Research Department ( email )

230 South LaSalle Street
Chicago, IL 60604-1413
United States

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