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The Interest Rate Elasticity of Mortgage Demand: Evidence From Bunching at the Conforming Loan Limit

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Abstract
The relationship between the mortgage interest rate and a household's demand for mortgage debt has important implications for a host of public policy questions. In this paper, we use detailed data on over 2.7 million mortgages to provide novel estimates of the interest rate elasticity of mortgage demand. Our empirical strategy exploits a discrete jump in interest rates generated by the conforming loan limit--the maximum loan size eligible for securitization by Fannie Mae and Freddie Mac. This discontinuity creates a large ``notch\" in the intertemporal budget constraint of prospective mortgage borrowers, allowing us to identify the causal link between interest rates and mortgage demand by measuring the extent to which loan amounts bunch at the conforming limit. Under our preferred specifications, we estimate that a 1 percentage point increase in the rate on a 30-year fixed-rate mortgage reduces first mortgage demand by between 2 and 3 percent. We also present evidence that about one third of the response is driven by borrowers who take out second mortgages while leaving their total mortgage balance unchanged. Accounting for these borrowers suggests a reduction in total mortgage debt of between 1.5 and 2 percent per percentage point increase in the interest rate. Using these estimates, we predict the changes in mortgage demand implied by past and proposed future increases to the guarantee fees charged by Fannie and Freddie. We conclude that these increases would directly reduce the dollar volume of new mortgage originations by well under 1 percent.

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  • Anthony A. DeFusco & Andrew D. Paciorek, 2014. "The Interest Rate Elasticity of Mortgage Demand: Evidence From Bunching at the Conforming Loan Limit," Finance and Economics Discussion Series 2014-11, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgfe:2014-11
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    More about this item

    Keywords

    Mortgage demand; interest rate elasticity; conforming loan limit; bunching;
    All these keywords.

    JEL classification:

    • D14 - Microeconomics - - Household Behavior - - - Household Saving; Personal Finance
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • R21 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Household Analysis - - - Housing Demand
    • R31 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Real Estate Markets, Spatial Production Analysis, and Firm Location - - - Housing Supply and Markets

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