Systematic Mistakes in the Mortgage Market and Lack of Financial Sophistication

Institutions often offer a menu of contracts to consumers in an attempt to create a separating equilibrium that reveals borrower types and provides better pricing. We test the effectiveness of a specific set of contracts in the mortgage market: mortgage points. Points allow borrowers to exchange an upfront amount for a decrease in the mortgage rate. We document that, on average, points takers lose about $700. Also, points takers are less financially savvy (less educated, older), and they make mistakes on other dimensions (e.g., inefficiently refinancing their mortgages). Overall, our results show that borrowers overestimate how long they will stay with the mortgage.

Keywords: Discount points, mortgage decision making, refinancing, leverage, financial literacy, household finance, inattentiveness

JEL Classification: D03, D12, D14, D18, G01, G21

Suggested Citation: Suggested Citation

Agarwal, Sumit and Ben-David, Itzhak and Yao, Vincent, Systematic Mistakes in the Mortgage Market and Lack of Financial Sophistication (March 1, 2016). Journal of Financial Economics (JFE), Forthcoming, Charles A. Dice Working Paper No. 2016-09, Fisher College of Business Working Paper No. 2016-03-9, Available at SSRN: https://ssrn.com/abstract=2548316 or http://dx.doi.org/10.2139/ssrn.2548316