Clasificación de la demanda

In line with the existing literature, the results in Table 5.2 support the importance of the mortgage terms and costs in mortgage product choice. A widening range between the SFRM and the VRM rates (RAT EDIF F\ ) is expected to increase the probability of VRM choice as this becomes the relatively cheaper product. This is reflected in our results, where an increase in the margin of the SFRM over the VRM of 100 basis points leads to a 55 percent increase in the probability of choosing a VRM product. Clearly households are very sensitive to relative interest rates in choosing their financing product. However, when we control for a potential non-linearity in the spread between SFRM and VRM related to income (RAT EDIF F\ × Income), our results suggest that borrowers with higher income are less sensitive to a widening spread between the rates of these two contracts. The discount offered on a HM contract (Discount) is less important in\

magnitude, however it is statistically significant and has the expected sign. For a 100 basis point rise in the discount between a VRM and a HM there is a 4.7 percent fall in the probability of observing a VRM product choice.

In addition, a 100 basis point increase in the VRM interest rate decreases the probability of taking a VRM by 9.4 percent. For example, the predicted probability of taking a VRM when the prevailing VRM rate is 6.9 percent (as in June 2005) is 61 percent; while when the prevailing rate is 9 percent (as in August 2008) the predicted probability is 41 percent.

Loans of greater than AUD $500,000 attract a further marginal increased probability of selecting VRM of about 22 percent. To put this in the Australian context, it is useful to know that the median (2006) house price in Sydney was $470,000.21

Loan ratios also affect mortgage choice. As default risk increases through higher loan- to-value ratios (LTV), households are less likely to choose a VRM over an alternative which offers some level of certainty.22 A LTV below 80 percent attracts a 50 percent discount on Basel capital requirements on lenders. At very high LTV, say 100 percent, the probability of observing a VRM is 51 percent, but at 80 percent LTV the probability of observing a VRM is 56 percent. Borrowers with low equity in their residential property

21

ABS House Price Indexes: Eight Capital Cities, June 2013: Catalogue 6416.02.

22_{Capone Jr and Cunningham [45] argue that borrowers with less initial equity (and higher LTVs)}

Chapter 5. Mortgage Choice Determinants: The Role of Risk and Bank Regulation114

prefer the initial low and certain payments in HMs and SFRMs. We return to the issue of LTVs in Section 5.6.

Macroeconomic conditions are often included as controls in mortgage choice studies, as they are presumed to provide information to both borrowers and lenders about ex- pectations of future states of the economy. Commonly chosen indicators include the unemployment rate, house price inflation and the slope of the yield curve or inflation expectations; see for example Dhillon et al. [73], Paiella and Pozzolo [150], Amromin et al. [10], Ehrmann and Ziegelmeyer [82].

Our results support the statistical significance of market conditions, although the effects are sometimes not large. For instance, a one percentage point rise in the unemployment rate – representing income risk – decreases the probability of a VRM by under 6 percent, and a one percentage point increase in the inflation rate – representing potential future interest rate risk – decreases the likelihood of VRM choice by only 1.1 percent.

Borrowers’ response to potential home equity gains is strongly reflected in the increased probability of observing a VRM as consumer sentiment around a dwelling index derived from the Westpac-Melbourne Institute survey improves. An increase in this buying sentiment index increases the probability of taking a VRM by 22 percent; the incentive provided by potential capital gains outweighs the savings from delayed repayments in a HM or SFRM. This result dominates the effect of observed house price inflation.23 Over the sample period the Australian government has provided a number of programs to boost home ownership for first-time home buyers (FHBs). Using the measure of net assistance from Dungey et al. [77], we find that increased support to FHBs leads to a small decrease in the probability of these borrowers taking a VRM in favor of the alternatives, however the effect is statistically insignificant.

Given that our data are provided by one major bank, albeit with national representa- tion, we also control for competition in the market by observing whether this bank is offering the lowest SFRM interest rate in the market on the month of application. When the bank is offering the lowest interest rate on a SFRM contract relative to the other banks, borrowers are more likely to take a VRM contract, but the effect is statistically insignificant.

23

The correlation coefficient between the change in the dwelling index and the house price inflation rate is -0.66.

Chapter 5. Mortgage Choice Determinants: The Role of Risk and Bank Regulation115

Our study excludes a number of interest rate control variables included in previous literature; in particular the spread between the long-term government bond rate and short-term bill rate, and the central bank official target rate.24 The VRM rate is closely related to the official short-term rate and the SFRM rate closely follows the market rate on the 3-year Australian Government bond.25 As these yields have been used to predict the rates in equations (5.3)-(5.5), they are omitted from the probit specification.