UC Berkeley

This thesis explores how households make financial decisions and how financial intermediaries interact with households by investigating mortgage refinance choices. Initially, the thesis concentrates on the mortgage market for low-to-moderate income households who are especially prone to financial market frictions. After finding evidence of significant welfare loss, I explore channels from both the household side and financial intermediary side that explain these frictions. Subsequently, the thesis explores the behavioral biases that explain prevalent inaction in mortgage refinancing and conducts analysis on the use of lender credits. Given the importance of the mortgage refinance channel in the efficiency of monetary policy pass-through, the final part of the thesis explores household interest rate expectation biases and their implications on mortgage refinance choices.Frictions in mortgage refinance choices exist not only in whether or when to refinance, but also in the type of mortgage households refinance into. Chapter 1, Frictions in Mortgage Refinance Choices: Evidence from Federal Housing Administration Mortgages studies frictions involved in mortgage refinance product choices. Using loan level data, I find that about 40% of FHA-to-FHA refinancers during 2009-2020 could have saved approximately $110 (10%) per month and $2,957 upfront by switching to a conventional Government Sponsored Enterprise (GSE) loan at refinance. Minority and low-income FHA borrowers are less likely to make the switch. These borrowers continue to pay an avoidable mortgage insurance premium (MIP), even though their property value appreciation are qualified for a GSE loan, since they do not reassess their property value when refinance. I then examine both demand-side and supply-side channels to explain these frictions. On the demand side, I find that property value information updates can reduce refinance frictions. Households who received an updated property tax bill are more likely to refinance to a GSE loan. On the supply side, I demonstrate that lenders may prefer FHA-to-FHA refinance loans due to higher upfront fees and securitization revenue. An exogenous increase in lenders’ revenue (cost) of originating FHA loans results in less (more) refinance to GSE mortgages.Households often make costly and systematic errors in mortgage refinancing, either by refinancing too early or delaying to the point of inaction. Chapter 2, coauthored with Mingzi Niu, Mortgage Refinance under Present Bias: Evidence From the Use of Lender Credits examines how present bias may explain these refinancing frictions. We develop a theoretical framework that incorporates present bias into refinancing decisions and derive closed-form solutions for optimal refinancing thresholds. Our model indicates that present-biased borrowers require larger interest rate drops to refinance and are more sensitive to changes in upfront costs. We further test our model in the setting of lender credits. Using U.S. mortgage data from 2010-2019, we identify lender credit usage through FHA loan features. We find borrowers using lender credits refinance earlier in interest rate cycles but achieve smaller rate reductions compared to those who pay closing costs out of pocket.The efficiency of monetary policy pass through into household sector rely on households forming interest rate expectations in alignment with policy goals. However, evidence shows household are subject to significant bias. In Chapter 3, coauthored with Hao Pang, Mortgage Rate Expectations and Refinance Choices, we use survey data to show evidence of biases in mortgage rate expectations. We find that professional forecasters often over-react to interest rate changes, while households tend to underreact. These frictions lead to mortgage refinance mistakes. Households with lower property values tend to refinance too early in declining rate environments, while households with higher property values often wait too long, missing optimal refinancing opportunities. These results contribute to the understanding of household interest rate expectation formation and household borrowing decisions.