The Mortgage Illusion

Abstract

We propose and test a new heuristic on the decision to buy or rent a house: the mortgage illusion, in which potential home buyers are influenced by the comparison between the monthly rental payment and the monthly mortgage installment, for fixed rate mortgages. We find experimental evidence that home buyers are more likely to buy when the monthly rental payment is higher than the monthly mortgage installment. Our experimental designs and results are robust to ownership bias and home buyers’ budget constraints. Financial literacy and numeracy do not help to overcome the mortgage illusion.

Keywords: mortgages, household decisions, experiment, behavioral finance

JEL Classification: C91, D12, G02, G21