This paper develops a model which explains how mortgage‐rate movements, transactions costs, changes in borrower income and house value, personal financial opportunities and the prepayment option embedded in fixed‐rate mortgages affect a financially flexible borrower's decision to refinance an existing loan while retaining the underlying home. Broadening the focus of previous analytical work, the model explains why households with similar mortgage loans may react differently as financial market conditions change. It contains definitive empirical predictions that are supported by an analysis of a choice‐based sample of individual loan transactions. Results suggest that refinancings are motivated both by movements in the level of interest rates and by borrowers' desires to alter their capital structures in the face of changing income and housing wealth.
ASJC Scopus subject areas
- Economics and Econometrics