Why Do Borrowers Make Mortgage Refinancing Mistakes?

Forthcoming, Management Science

46 Pages Posted: 7 Jun 2014 Last revised: 1 Jun 2015

Sumit Agarwal

National University of Singapore

Richard J. Rosen

Federal Reserve Bank of Chicago - Economic Research

Vincent W. Yao

Georgia State University - J. Mack Robinson College of Business

Multiple version iconThere are 2 versions of this paper

Date Written: March 18, 2015

Abstract

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.

Keywords: Household Finance, Mortgages, Refinance, Option Value, Financial Crisis, Rational Inattention

JEL Classification: G11, G21

Suggested Citation

Agarwal, Sumit and Rosen, Richard J. and Yao, Vincent W., Why Do Borrowers Make Mortgage Refinancing Mistakes? (March 18, 2015). Forthcoming, Management Science. Available at SSRN: https://ssrn.com/abstract=2446753 or http://dx.doi.org/10.2139/ssrn.2446753

Sumit Agarwal

National University of Singapore ( email )

15 Kent Ridge Drive
Singapore, 117592
Singapore
8118 9025 (Phone)

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

Richard J. Rosen (Contact Author)

Federal Reserve Bank of Chicago - Economic Research ( email )

230 South LaSalle Street
Chicago, IL 60604
United States
312-322-6368 (Phone)
312-294-6262 (Fax)

Vincent W. Yao

Georgia State University - J. Mack Robinson College of Business ( email )

35 Broad Street
Atlanta, GA 30303-3083
United States

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