Atlantic Economic Journal

, Volume 15, Issue 2, pp 33–41 | Cite as

Why are mortgage rates so uniform?

  • Eva Marikova Leeds
Articles
  • 13 Downloads

Conclusion

Any reasonable model of mortgage lending concludes that interest rates depend on loan and borrower characteristics. In this paper, the rate is a function of the loan-to-value ratio, the parameters of the densities of future price of housing and income, deposit rate, and cost of foreclosure.

Nevertheless, in practice, each lender charges only one rate to all borrowers. This is first explained by the difficulty of estimation of the parameters of the density functions. Since lenders cannot categorize their borrowers, they treat them uniformly and set minimum standards to minimize the risk of default by each borrower. Mortgage insurance, moreover, enables lenders to lend risklessly outside of the range in which they can operate risklessly on their own.

Second, mortgage rate uniformity is explained by the lenders' risk aversion.

Third, when borrowers are separated into discrete categories, uniform rates can result from perfect categorization of borrowers with respect to the future value of the relevant random variables. It is more likely, however, that lenders cannot categorize borrowers perfectly and that interest rates vary substantially among categories. As rates jump from one category to the next and borrowers are reluctant to gain small increases in loan size at significantly higher rates, lenders respond by offering only the basic category of loans.

Keywords

Density Function Interest Rate Deposit Rate Risk Aversion International Economic 

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References

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Copyright information

© Atlantic Economic Society 1987

Authors and Affiliations

  • Eva Marikova Leeds
    • 1
  1. 1.Franklin and Marshall CollegeUSA

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