Systematic Mistakes in the Mortgage Market and Lack of Financial Sophistication

45 Pages Posted: 12 Jan 2015 Last revised: 23 Jun 2016

Sumit Agarwal

Georgetown University - Department of Finance

Itzhak Ben-David

Ohio State University - Fisher College of Business, Finance Department; National Bureau of Economic Research (NBER)

Vincent W. Yao

Georgia State University - J. Mack Robinson College of Business

Date Written: March 1, 2016

Abstract

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

Agarwal, Sumit and Ben-David, Itzhak and Yao, Vincent W., 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

Sumit Agarwal

Georgetown University - Department of Finance ( email )

3700 O Street, NW
Washington, DC 20057
United States
202-687-8207 (Phone)

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

Itzhak Ben-David

Ohio State University - Fisher College of Business, Finance Department ( email )

2100 Neil Avenue
Fisher 700D
Columbus, OH 43210-1144
United States
773 988 1353 (Phone)

HOME PAGE: http://fisher.osu.edu/fin/faculty/Ben-David/index.htm

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

HOME PAGE: http://fisher.osu.edu/fin/faculty/Ben-David/

Vincent W. Yao (Contact Author)

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

35 Broad Street
Atlanta, GA 30303-3083
United States

Paper statistics

Downloads
285
Rank
86,729
Abstract Views
1,395