NCPA - National Center for Policy Analysis

Home Buying Decisions Driven by Leverage

July 14, 2015

The sensitivity of housing demand to mortgage rates and down payment requirements is key to understanding the effect of monetary and macroprudential policies on the housing market.

In Andreas Fuster and Basit Zafar's study in an initial scenario, all households had to make a 20 percent down payment. In the second scenario, their down payment could be as low as five percent of the purchase price. Based on these scenarios, the authors find:

  • On average, willingness to pay (WTP) increases by about 15 percent when households can make a down payment as low as five percent of the purchase price instead of having to put down 20 percent.
  • Fourteen percent of the households that were current homeowners increased their willingness to pay by more than 25 percent.
  • 41 percent of households that were current renters increased their willingness to pay by more than 25 percent.

Renters also tend to choose lower down payment fractions than current owners; for instance, 59 percent of renters but only 36 percent of owners choose a down payment fraction of 10 percent or lower.

They also studied how respondents reacted to changes in the mortgage rate. For this purpose, they randomly assigned respondents to either a 4.5 percent or 6.5 percent mortgage interest rate.  As another way to measure the effect of the mortgage rate, in a third scenario the authors "flip" the rate assigned to each respondent, thereby obtaining a direct estimate of how much respondents change their WTP when mortgage rates change. The findings are very similar across the two approaches: when the mortgage rate is 6.5 percent instead of 4.5 percent, WTP is reduced by about 5 percent on average (and there is little systematic variation across different respondent types).

The findings suggest that the strength of housing demand is strongly affected by household wealth, income and the quantity of available financing. Additionally interest rates seem to play a less important role than commonly thought.

Source: Andreas Fuster and Basit Zafar, "The Sensitivity of Housing Demand to Financing Conditions: Evidence from a Survey," Federal Reserve Bank of New York, March 2015.


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