forthcoming in International Economic Review

Interest-Only Mortgages and Consumption Growth: Evidence from a Mortgage Market Reform

We use household-level data to analyze how the introduction of interest-only mortgages in Denmark affected consumption expenditure and borrowing. Using an ex-ante measure of exposure to the interest-only mortgage reform motivated by mortgage-payment and leverage constraints, we show households more likely to use an interest-only mortgage to relax their mortgage-payment constraint increased consumption following the reform. This increase in consumption is financed by borrowing at the time of refinancing and by borrowers with lower pre-reform leverage and higher needs for liquidity. We find even larger post-reform consumption growth for the leverage-constrained homeowners through house-price growth stimulated by the reform.