Down Payment and Mortgage Rates: Evidence from Equity Loans
49 Pages Posted: 27 Feb 2018
Date Written: February 23, 2018
We present new evidence that lenders use down payment size to price unobservable borrower risk. We exploit the contractual features of a UK scheme that helps home buyers top up their down payments with equity loans. We find that a 20 percentage point smaller down payment is associated with a 22 basis point higher interest rate at origination, and a higher ex-post default rate. Lenders see down payment as a signal for unobservable risk, but the relative importance of this signal is limited, as it accounts for only 10% of the difference in mortgage rates between loans with 75% and 95% loan to value ratio.
Keywords: Mortgage design; asymmetric information; leverage; housing policy
JEL Classification: G21; R20; R30
Suggested Citation: Suggested Citation