The Borrower's Choice of Fixed and Adjustable Rate Mortgages in the Presence of Nominal and Real Shocks

This paper concerns the conditions under which borrowers select fixed and adjustable rate mortgages. The novelty of the paper lies in its capability to analyze the effect of nominal and real shocks separately. The fixed rate mortgage (FRM) versus the adjustable rate mortgage (ARM) choice is determined by the expected real interest rate differential, initial wealth, income, expected real and nominal income risk exposure-measured by different parameters-the value of the house, the appreciation of the house and the influence of the variance of nominal and real shocks. Results differ according to whether or not borrowers are restricted by the loan-to-value constraint. Copyright American Real Estate and Urban Economics Association.