Fixed or adjustable - mortgage choice in Australia

Abstract

This study considers factors linked to household preference for fixed rate mortgages (FRMs) or adjustable rate mortgages (ARMs). It does so examining mortgage choice in Australia, a market where price differences between FRMs and ARMs are relatively muted compared to the United States, enabling a greater role for household characteristics in mortgage choice. Unlike much of the existing literature, which identifies price as the dominant factor, it finds household characteristics matter, mostly by influencing household ability to manage the interest expense risk of an ARM. A household’s level of buffer-stock savings is found relevant for mortgage choice, affirming the view it has a major influence on household ability to manage the interest expense risk of an ARM. Also relevant is whether a household has spare cash for savings or investment. Both are positively linked with the probability of a household choosing an ARM. Households with less capacity to manage the interest expense risk of an ARM are found to be more likely to choose a FRM. This study tests the relevance of home equity for mortgage choice, finding it less important, despite high expectations and robust rationale for it to be among the key factors for mortgage choice. Tests on different submarkets reveal differences in approaches to mortgage choice. Significant factors mostly act in the anticipated manner. When this is not the case this may be interpreted as evidence of greater likelihood of making an investment mistake.