Mortgage Choice and Inflation Experiences in the Euro Area

ABSTRACT

Households' mortgage choice in the euro zone shows considerable heterogeneity, both across and within country. The persistence of different preferences when choosing between an adjustable-rate mortgage (ARM) versus a fixed-rate mortgage (FRM) two decades after introducing a common currency is a puzzle. We argue that these patterns can be explained by the long-lasting effect of personal experiences of high-inflation periods prior to joining the euro zone. Using representative micro-data of 9 countries from the Eurosystem’s Household Finance and Consumption Survey, we show that past exposure to higher inflation predicts significantly lower probability of holding an FRM. The sign of the result is the opposite of what have recently been found in the US. We link our results to the theoretical literature on households’ risk management in mortgage financing decisions and argue that prepayment penalties in the euro zone increase the inflation risk (i.e. the uncertainty of real payments) of an FRM. In line with this, we provide evidence that personal inflation experiences affect risk attitudes: households that experienced high and volatile inflation report lower willingness to take financial risk.

Keywords:

Behavioral finance, experience effects, financial contracts, household finance, inflation, mortgage choice

Presented at:

Banque de France-CEPR-ECB Conference on Monetary Policy Challenges for European Macroeconomies (Paris), LACEA LAMES Annual Meeting (Lima), HEC Paris Finance PhD Workshop (Paris), XXXVII Jornadas Anuales de Economía Banco Central del Uruguay (Montevideo), 4th Behavioral Macroeconomics Workshop (Bamberg), Spring Meeting of Young Economists (Orleans), CREi Macro Lunch, CREi International Lunch