Refinancing Cross-Subsidies in the Mortgage Market

Abstract

Evidence from a range of countries reveals that household inaction in mortgage refinancing can be pervasive despite financial incentives to take action. Inactive households may implicitly cross-subsidize active households, allowing competitive lenders to set lower average mortgage rates. To provide a money-metric assessment of cross-subsidies, we construct a model of household refinancing and structurally estimate it on rich administrative data on the stock of loans in the U.K. mortgage market in June 2015. We estimate sizeable cross-subsidies during this sample period, from relatively poorer households and those located in less-wealthy areas towards richer households and those located in wealthier areas. The findings over this sample period highlight how the design of household finance markets can contribute to wealth inequality. Estimated cross-subsidies may differ in more recent periods given changes in the UK mortgage market since 2015.

Keywords: Mortgages, refinancing, cross-subsidies, wealth inequality, household inaction, household finance

JEL Classification: G21, G50, N20, R21, R31, L51, D63