The Interest Rate Elasticity of Mortgage Demand: Evidence from Bunching at the Conforming Loan Limit

62 Pages Posted: 7 Feb 2014

Date Written: January 15, 2014

Abstract

The relationship between the mortgage interest rate and a household's demand for mortgage debt has important implications for a host of public policy questions. In this paper, we use detailed data on over 2.7 million mortgages to provide novel estimates of the interest rate elasticity of mortgage demand. Our empirical strategy exploits a discrete jump in interest rates generated by the conforming loan limit -- the maximum loan size eligible for securitization by Fannie Mae and Freddie Mac. This discontinuity creates a large "notch" in the intertemporal budget constraint of prospective mortgage borrowers, allowing us to identify the causal link between interest rates and mortgage demand by measuring the extent to which loan amounts bunch at the conforming limit. Under our preferred specifications, we estimate that a 1 percentage point increase in the rate on a 30-year fixed-rate mortgage reduces first mortgage demand by between 2 and 3 percent. We also present evidence that about one third of the response is driven by borrowers who take out second mortgages while leaving their total mortgage balance unchanged. Accounting for these borrowers suggests a reduction in total mortgage debt of between 1.5 and 2 percent per percentage point increase in the interest rate. Using these estimates, we predict the changes in mortgage demand implied by past and proposed future increases to the guarantee fees charged by Fannie and Freddie. We conclude that these increases would directly reduce the dollar volume of new mortgage originations by well under 1 percent.

Keywords: Mortgage demand, interest rate elasticity, conforming loan limit, bunching

JEL Classification: R3, R30, R38, G21

Suggested Citation

DeFusco, Anthony and Paciorek, Andrew, The Interest Rate Elasticity of Mortgage Demand: Evidence from Bunching at the Conforming Loan Limit (January 15, 2014). FEDS Working Paper No. 2014-11. Available at SSRN: https://ssrn.com/abstract=2391941 or http://dx.doi.org/10.2139/ssrn.2391941

Anthony DeFusco

Northwestern University - Kellogg School of Management ( email )

2211 Campus Drive
Evanston, IL 60208
United States

HOME PAGE: http://www.anthonydefusco.com

Andrew Paciorek (Contact Author)

Federal Reserve Board ( email )

20th & C. St., N.W.
Mailstop 80
Washington, DC 20551
United States

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