Abstract
Policymakers have expressed concern that some mortgage holders do not understand or correctly choose their mortgage products, especially alternative mortgage products (AMPs), also known as interest-only mortgages, with back-loaded payments.
In this Nottingham School of Economics working paper, John Gathergood and Joerg Weber investigate the impact of consumer financial sophistication on the decision to choose an AMP over a standard repayment mortgage. They include a new set of test-based measures of financial literacy into a representative survey of UK households, specifically developed to test ability of respondents to understand key features of mortgage contracts.
Their results show that holders of standard repayment mortgages answer questions on financial literacy significantly better than those holding AMPs: on average, those with AMPs answer 1.56 (out of four) questions correctly - those with standard mortgages answer 2.57 questions correctly. Overall, their results show that poor financial literacy raises the likelihood of choosing an AMP. Financially literate individuals are also more likely to choose an adjustable rate mortgage, suggesting they avoid paying the term premium of a fixed rate mortgage.
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CFCM Discussion Paper 15/07, Financial Literacy, Present Bias and Alternative Mortgage Products by John Gathergood and Joerg Weber
Authors
John Gathergood and Joerg Weber
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Posted on Wednesday 29th July 2015