Fixed rate versus adjustable rate mortgages: Evidence from euro area banks

Why do residential mortgages carry a fixed or an adjustable interest rate? To answer this question we study unique data from 103 banks belonging to 73 different banking groups across twelve countries in the euro area. To explain the large cross-country and time variations observed, we distinguish between household conditions that determine the local demand for credit and the characteristics of banks that supply credit. As bank funding mostly occurs at the group level, we disentangle these two sets of factors by comparing the outcome observed for the same banking group across the different countries. Local household conditions dominate. In particular we find that the share of new loans with a fixed rate is larger when: (1) the historical volatility of inflation is lower, (2) the correlation between unemployment and the short-term interest rate is higher, (3) households' financial literacy is lower, and (4) the use of local mortgages to back covered bonds and of mortgage-backed securities is more widespread.

Automated summary

Residential mortgages have fixed or adjustable interest rates depending on household conditions and bank characteristics. Research shows that the type of interest rate for mortgages is related to factors such as inflation volatility, correlation between unemployment and short-term interest rates, financial literacy of households, and the extent of using local mortgages to back bonds and securities.