Mortgage Choice Determinants: The Role of Risk and Bank Regulation

This paper sheds new light on the role of borrower characteristics in mortgage product choice, and how these are impacted by regulatory capital requirements.Using rich loan-level data from the Australian market we analyse the way in which these risk effects impact the choice between adjustable rate mortgages and a range of complex mortgages which provide reduced initial payments. For the first time we find that all three of income, wealth and mobility risks play a role in product choice. We also investigate the role of regulatory capital requirements in an environment where banks hold mortgage risk on their balance sheet and find that the Basel capital discounts based on loan-to-valuation ratios divide otherwise similar borrowers between ARM and CM product choices.