The Impact of Interest-Only Loans on Affordability

Abstract

We study the 2000s Danish legalization of interest-only (IO) loans, a mortgage market innovation aimed at increasing affordability and homeownership rates for cash-strapped buyers by substantially reducing first-year payments. Our results show that IO mortgages rapidly became popular with both the targeted cash-strapped borrowers and mortgage applicants spanning the wealth and income distributions. Just three years after policy implementation, IO mortgages constituted half of all outstanding Danish mortgages. The introduction of IO loans thus led to an increase in housing turnover and transactions. However, as these increases were dispersed across the distribution of homeowners, they did not lead to any changes in homeownership rates for the targeted group or allow any underserved buyer groups to enter the market. Instead, the IO reform coincided with an increase in house prices. Broadly, our policy analysis documents how reforms targeting housing affordability and inequality can be exploited by the wider population, limiting intended effects.

Keywords: Interest Only Mortgages; Housing Affordability; Mortgage Lending

JEL Classification: D1, G21, R3, R21, R31, E30