The Effect of Interest Rates on Home Buying: Evidence from a Shock to Mortgage Insurance Premiums

Abstract

Abstract Regression discontinuity estimates indicate that home buying is highly responsive to interest rates in a large segment of the population. A surprise 50 basis point cut in the effective interest rate for mortgages insured by the Federal Housing Administration (FHA) led to an immediate 14 percent increase in home buying among the FHA-reliant population. We show that this large, extensive-margin effect arises from the rate cut helping borrowers overcome maximum debt payment to income (DTI) thresholds. We conclude that binding DTI constraints are an important feature of the mortgage market that amplify the effect of interest rate shocks.