With reference to How does monetary policy pass-through affect mortgage default? Evidence from the Irish mortgage market by David Byrne, Robert Kelly, and Conor O’Toole. 04/RT/2017
With the loosening structure of the monetary policy by central banks after the global financial crisis, which allowed the mortgage interest rates to be lower which could have led to a lower default rate on mortgages. This post will focus on two different types of mortgages the Standard Variable Rate mortgage (most commonly known as SVR) and the Tracker mortgage.
A SVR is a mortgage where the lender has the ability to decide when and if the interest rate on the loan will change while a Tracker mortgage is where the interest rate is set to a certain percentage above the European Central Bank interest rate. As the number of Tracker mortgages were increasing while the European Central Bank interest rate was decreasing, the banks started to lose money on them as the interest rate on the mortgage payments were not high enough to cover the cost of the loan. This led to an increase of the interest rates on SVR mortgages to compensate for the money lost in Tracker mortgages.
The Irish housing market provided an opportunity to investigate the correlation from changes in interest rates and how that affects the mortgage default rate. Following the initial impact of the financial crisis with Ireland being severely impacted, there was a decrease in disposable income and house prices with an increase of the unemployment rate. These effects led to an increase of mortgage defaults. The highest point being 17% of residential mortgages in Ireland having outstanding payments.
Focusing on these two mortgage types that originated before this financial crisis, we can determine whether not the current interest rate can affect the default rate. With this there could be a link to the current monetary policy and the amount of defaults on mortgages.
To determine whether or not this theory was true, they had to identify the different mortgage rates to the probability of defaulting, focusing on origination in 2003 through 2008 when these two types of mortgages were offered. In the data set, it was found with having lower interest rates, a 1% deduction in a monthly installment lead to 5.7% decrease in probability of defaulting within the year. As well as having negative equity on a home can balance out the gains coming from lower policy rates. That indicates a correlation between monetary policy and an asset price change in the mortgage market.
Although the sole aim of monetary policy is not focused on mortgage rates, it is still important to be aware of how rate changes can impact the economic activity of a country. The data showed that default rates were impacted from the pass-through of the lower interest rates. In return, a monetary policy willing to adapt promotes stability through the mortgage market and may reduce the amount of mortgage defaults. This will lead to a more efficient bank lending channel within an expansionary monetary policy period.