Why do borrowers choose ARMs over FRMs?: A behavioral investigation

Masaki Mori · Alan J. Ziobrowski

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Decision-Making and Behavioral Economics Housing Market and Economics Financial Literacy, Pension, Retirement Analysis

Abstract

A considerable number of U.S. borrowers still choose adjustable rate mortgages (ARMs) over fixed rate mortgages (FRMs) even when interest rates are historically very low. This study examines the psychological reasons for the popularity of ARMs by testing the Prospect theory’s reflection hypothesis. Experiments are conducted using business professionals. The results suggest that psychological factors may explain why ARM borrowers tend to ignore the associated risk factors, focusing heavily upon pricing factors when choosing mortgage type. The results also indicate that borrowers may be viewing mortgage selection as part of a positive choice; namely, acquiring a home.

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