Mortgage Choice and Expenditure over the Lifecycle: Evidence from Expiring Interest-Only Loans

Abstract

We study how homeowners’ consumption responds to a negative and anticipated dis- posable income shock: the beginning of the amortization period on interest-only mort- gages. We identify spending behavior through an event study approach, by matching loan-level data that covers the universe of Danish mortgages to detailed administrative registries on borrowers. In response to an average increase in installments worth 9 per- cent of income, consumption drops by 3 percent of income, when amortization begins. The reduction in expenditure is persistent. Borrowers who fail to smooth consumption are highly leveraged and likely to be denied a new interest-only loan, upon expiration.

Keywords: Interest-only mortgages, Consumption, Hand-to-mouth

JEL Classification: D15, E21, G51