Linda Sandris Larsen

How Do Homeowners Use Interest-Only Mortgages?

Using a unique data set with detailed information on Danish households and their mortgages, we show that young and old households are more likely to use IO mortgages compared to middle-aged households. Young households use IO mortgages to postpone repayment to a period with higher income, old households because it allows them to circumvent an otherwise binding liquidity constraint. Through different channels, IO mortgages thus facilitate consumption smoothing for young and old households. We further examine how households with IO mortgages differ from households with repayment mortgages in terms of leverage, debt and asset composition, and pension contributions.Using a unique Danish data set with detailed information on household characteristics and the mortgages they hold, we examine the pros and cons of interest-only (IO) mortgages. We find that households with IO mortgages are more leveraged and consume more than households with repayment mortgages. We also find, however, that IO mortgages facilitate consumption smoothing for young households expecting increasing income. Furthermore, IO mortgages help financially constrained older households free up liquidity and thus avoid cutting consumption or selling their home. Out of their total debt, households with IO mortgages have a lower fraction of expensive non-mortgage debt, compared to households with repayment mortgages, indicating that IO mortgages allow households to reduce life-time borrowing costs. Finally, households with IO mortgages have a higher stock market participation rate and make larger voluntary pension contribution, indicating that IO mortgages facilitate more diversified savings.