FINNOV

ABSTRACT: Household decisions regarding the type of financing real estate purchases have significant welfare consequences. In general, there are two loans available for households: fixed-rate mortgage (FRM) contracts and adjustable-rate mortgage (ARM) contracts. We investigate the welfare effects of fixed-rate and adjustable-rate mortgage contracts for Czech households by calibrating and solving a life-cycle model. Similar investigations have been done only for US households. The reason is that calibration of the life-cycle model depends on the household labor income profile and construction of this profile is time consuming and depends heavily on availability of adequate data. We compare the distribution of utility in simulations under FRM and ARM and find that ARM is preferred to FRM for the Czech households. This is somewhat surprising as the labor income is still relatively small as compared to the US households and real estate prices are higher in the Czech Republic relative to income and close in absolute values. It seems that the premium for avoiding the risk of default in bad times is too high.

KEY WORDS: Adjustable rate mortgage; fixed rate mortgage; household finance; housing; life-cycle model.

JEL CLASSIFICATION: G21, R21, R31