Choosing Between Fixed and Adjustable Rate Mortgages: Note

Abstract

Introduction In recent years mortgage borrowers have been given a wide variety of financing methods from which to choose (e.g., Guttentag 1983; Barnett and McKenzie 1984). Examples include assumptions, adjustable rates, shared appreciation, growing equity, and numerous others. By far, the dominant two have been the standard fixed rate and the adjustable rate mortgage. ' Beginning with regulation changes in 1979, adjustable rate mortgage lending, at first, was fairly restricted, but with the major deregulation change in 1981, the types of adjustable rate mortgages have proliferated.2 Now lenders have the flexibility to use numerous indexes, including inflation and disposable-income indexes, make interest rate changes independent of payment changes, and allow negative amortization. The purpose of this paper is to examine the choice between fixed and adjustable rate mortgages.3 Two views have dominated the theoretical literature: one that emphasizes the irrelevance of borrower characteristics in the mortgage choice decision given the prices and terms of the contract, and one that focuses on the potential impact of borrower characteristics assuming asymmetric information.4 This paper is the first to examine empirically the impact of pricing and borrower characteristics on the choice of mortgage contract.

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