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Thursday, October 01, 2015

'The Costs of Interest Rate Liftoff for Homeowner'

Two posts on housing. First, how will an increase in interest rates impact mortgage markets?:

The costs of interest rate liftoff for homeowners: Why central bankers should focus on inflation, by Carlos Garriga, Finn Kydland, and Roman Šustek: The Federal Reserve Bank and the Bank of England left their policy interest rates unchanged this month... But an interest rate liftoff in the near future remains on the table in both the US and the UK, provided the headwinds from China ease off and there is further evidence of improvements in the domestic economy. Inflation, however, still hovers in both economies stubbornly around zero percent. 
Interest rates set by central banks influence the economy through various transmission mechanisms. But one channel affects the typical household directly – the cost of servicing mortgage debt. ... Changes in the interest rate set by the central bank affect the size of mortgage payments, but differently for different types of loans. In addition, the real value of these payments depends on inflation. ...
Policy implications
To sum up, the effects of the liftoff on homeowners depend on three factors:
  • The prevalent mortgage type in the economy (fixed or adjustable rate mortgages);
  • The speed of the liftoff; and
  • What happens to inflation during the course of the liftoff.
If inflation stays constant at near zero then in the US, where fixed rate mortgage loans dominate, the liftoff will affect only new homeowners. In the UK, where adjustable rate mortgage loans dominate, the negative effects will in contrast be felt strongly by both new and existing homeowners.
However, if the liftoff is accompanied by sufficiently high inflation as in our examples, the negative effects will be weaker in both countries. In the US, the initial negative effect on new homeowners will be compensated by gradual positive effects on existing homeowners. And in the UK, provided the liftoff is sufficiently slow, neither existing nor new homeowners may face significantly higher real costs of servicing their mortgage debt. But if the liftoff is too fast, both types of homeowners in the UK will face higher real mortgage costs in the medium term, even if the liftoff is accompanied by positive inflation with no change in real rates.
Therefore, if the purpose of the liftoff is to ‘normalize’ nominal interest rates without derailing the recovery, central bankers in both the US and the UK should wait until the economies convincingly show signs of inflation taking off. Furthermore, the liftoff should be gradual and in line with inflation.

Second, allowing less creditworthy borrowers to refinance could stimulate the economy:

‘Home Affordable Refinancing Program’: Impact on borrowers, by Sumit Agarwal, Gene Amromin, Souphala Chomsisengphet, Tomasz Piskorski, Amit Seru, and Vincent Yao: Mortgage refinancing is one of the main ways households can benefit from a decline in the cost of credit. This column uses the US Government’s Home Affordable Refinancing Program (HARP) as a laboratory to examine the government’s ability to impact refinancing activity and spur household consumption. The results suggest that less creditworthy borrowers significantly increase their spending following refinancing. To the extent that such borrowers have the largest marginal propensity to consume, allowing them to refinance under the program could increase overall consumption and alleviate uneven economic outcomes across the country.

    Posted by on Thursday, October 1, 2015 at 09:27 AM in Economics, Fiscal Policy, Housing | Permalink  Comments (38)


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