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Finance and Economics Discussion SeriesFederal Reserve Board,Washington,D.C.ISSN 1936-2854(Print)ISSN 2767-3898(Online)Inframarginal Borrowers and the Mortgage Payment Channel ofMonetary PolicyDaniel Ringo2024-069Please cite this paper as:Ringo,Daniel(2024).“Inframarginal Borrowers and the Mortgage Payment Channel ofMonetary Policy,”Finance and Economics Discussion Series 2024-069.Washington:Boardof Governors of the Federal Reserve System,https:/doi.org/10.17016/FEDS.2024.069.NOTE:Staffworking papers in the Finance and Economics Discussion Series(FEDS)are preliminarymaterials circulated to stimulate discussion and critical comment.The analysis and conclusions set forthare those of the authors and do not indicate concurrence by other members of the research staffor theBoard of Governors.References in publications to the Finance and Economics Discussion Series(other thanacknowledgement)should be cleared with the author(s)to protect the tentative character of these papers.Inframarginal Borrowers and the Mortgage PaymentChannel of Monetary PolicyDaniel RingoFederal Reserve BoardJuly 30,2024AbstractDespite the widespread use of fixed-rate mortgages in the United States,I show that monetarypolicy is effectively passed through to aggregate outstanding mortgage debt service.Using creditbureau,lender,and servicer data on mortgage payments and originations and exogenous mone-tary policy shocks,I estimate a mortgage rate semi-elasticity of payments over 10.Inframarginalborrowershouseholds whose choice to buy a home or refinance does not depend on the partic-ular monetary policy decision under considerationare the most important conduit,explainingover half of the pass-through.Consistently large flows of inframarginal borrowing relative to thestock of outstanding debt account for the strength of this channel.Households with adjustable-ratemortgages and marginal refinancers,the focus of much of the literature on monetary policys effecton mortgage borrowers,each explain about 20 percent of the pass-through.I show the mortgagepayment channel induces a lag in the operation of policy,as the cumulative effects on debt servicebuild over time in response to persistent shocks to longer-term rates.Estimated magnitudes suggestthat mortgage payments are a primary channel by which monetary policy affects consumption.Keywords:Monetary policy;interest rates;refinancing channel;debt serviceJEL codes:G21;E43;E52.MS93,BoardofGovernorsoftheFederalReserveSystem,WashingtonD.C.20551daniel.r.ringofrb.gov.Thanks to Neil Bhutta,John Driscoll,and seminar participants at the Federal Re-serve Board and Ghent University Empirical Macroeconomics Workshop for helpful comments.The analysisand conclusions set forth are those of the author and do not indicate concurrence by other members of theresearch staffor the Board of Governors.11IntroductionMonetary policy can affect households consumption via their debt service payments,in-creasing their disposable incomes net of required payments as interest rates decrease andvice versa.Residential mortgage debt represents the outright majority of all household debtand is the largest source of debt service obligations,and so should be a potent channel bywhich monetary policy can influence consumer demand.In the United States,however,thepopularity of fixed-rate mortgages presents an obstacle to the pass-through of interest ratechanges to payments.When rates rise,debtor households will hang on to their old rates andbe unaffected.When rates fall,only a fraction of households for whom refinancing would beprofitable exercise their option to do so.The frictions inherent in this process have moti-vated a growing body of literature analyzing the refinancing channel of monetary policy.1Inan international context,it is commonly argued that the prevalance of fixed-rate mortgagesdampens the effectiveness of monetary policy in countries like the U.S.2In this paper,I show that the pass-through of monetary policy shocks to mortgagepayments in the U.S.is actually quite robust due to the large volume of borrowing byinframarginal borrowers.These are households whose decision to take out a new loan doesnot depend on the particular monetary policy action under consideration,but whose paymentfor that new loan still depends on the stance of policy.Importantly,inframarginal borrowersinclude households who are borrowing for the purposes of home purchase,refinancing,orany other ends.While only a small percentage of households engage in any new mortgageborrowing in a given year,in dollar terms annual new borrowing represents approximatelyone quarter of the outstanding stock of household mortgage debt.This is because newloans tend to be larger than the unpaid principal balance of existing loans,and explains thestrength of the mortgage payment channel.Historically,a large percentage of mortgage debthas carried a recently determined interest rate.The effect of a typical monetary policy shock on the monthly payments of an infra-marginal borrower is small relative to that experienced by a marginal refinancera household1See Amromin,Bhutta and Keys(2020)for a helpful summary.2See,e.g.,Bernanke(2007),Calza,Monacelli and Stracca(2013),Rubio(2011),or Kim and Lim(2020).2that would be induced into or out of refinancing their current mortgage by a small changein rates.However,inframarginal borrowers are so much more numerous than marginal bor-rowers that the inframarginal channel is more than twice as important for the pass-throughof rate shocks to aggregate payments.I find that over the last 25 years,a monetary pol-icy shock which cuts mortgage rates by only 7 basis points would reduce aggregate annualmortgage payments by approximately$9 billion in 2023 dollars.Inframarginal borrowerswould account for about$5 billion of this reduction,and marginal refinancers$2 billion.An additional$2 billion would go to the minority of borrowers with adjustable-rate mort-gages(ARMs),although this latter channel has diminished in recent years.Marginal homepurchase borrowers and the intensive margin of borrowing(i.e.,the amount borrowed con-ditional on getting a loan)are not significant channels of pass-through to payments in thefirst few years post-shock.The stance of monetary policy and the level of mortgage rates are endogenous to the stateof the economy.To consistently estimate the effects of policy decisions,I therefore exploitvariation from the exogenous,unanticipated components of rate responses to Federal OpenMarket Committee(FOMC)announcements.I begin by estimating the effects of monetarypolicy shocks on mortgage interest rates.It is important here to recognize that mortgageinterest rates are tied to yields on relatively longer-maturity debt(as a typical mortgagewill endure for years before prepaying)and the Federal Reserve has tools at its disposalthat affect different portions of the yield curve differently.The Fed can directly control veryshort-term rates by setting the overnight federal funds rate.Longer-term rates depend moreon investors beliefs about the future path of monetary policy decisions,and the Fed canattempt to influence these beliefs via forward guidance and asset purchases.I therefore usethe series of monetary policy shocks estimated by Swanson(2021),who separately identifiedshocks to the federal funds rate,forward guidance,and large-scale asset purchases(LSAP)contained in FOMC announcements.3Using the local projections estimator of Jord a(2005),3Lewis(2023)also estimates shock series that disentangle these components using different identifyingassumptions than Swanson(2021).In addition,Lewis(2023)attempts to isolate a fourth component,theFed information effect.In Appendix Section A.1 I show my results are robust to using these alternativeshocks series.3I estimate that a one standard deviation forward guidance shock raises mortgage rates byan average of 7.4 basis points over the three years post-shock.4Shocks to the federal fundsrate do not show any demonstrable effect on mortgage rates,however.The LSAP shock isestimated to have a strong initial effect on mortgage rates,but this quickly fades.Next,I estimate how the average payments of mortgage borrowers are affected by mon-etary policy shocks empirically.I construct a time series of the average mortgage paymentsof all outstanding mortgage borrowers using nationally representative credit bureau datafrom 1999 through 2023.Again using the local projections estimator,I estimate that a onestandard deviation forward guidance shock increased the average payments of borrowers by0.89 percent after three years,or approximately$9 billion per year.Putting the estimates to-gether,each basis point increase in mortgage rates is estimated to increase annual paymentsby over$1 billion;in other words,the interest rate semi-elasticity of mortgage payments isabout 10.The estimated effects on mortgage debt service are large enough to explain much of theconsumption response to monetary policy shocks.Cloyne,Ferreira and Surico(2020)esti-mate that in the U.S.a 25 basis point generic monetary policy shock would decrease durableand non-durable consumption by approximately 0.9 and 0.15 percent,respectively,threeyears post-shock.With receent annual personal consumption expenditures of approximately$2 trillion and$17 trillion in these categories,this implies a total reduction of about$45billion per year.My estimates suggest that a 25 basis point shock to mortgage rates wouldincrease annual mortgage payments by about$30 billion by year three.If the marginalpropensity to consume out of a persistent change in disposable income is high,most of theeffect of monetary policy on consumption can therefore be explained by the direct effect of themortgage payment channel.5Any multiplier effects from the shock to mortgage borrowers4Prior studies,such as Hamilton(2008),Gorea,Kryvtsov and Kudlyak(2022),and Ringo(2024),haveshown the effect of forward guidance on mortgage rates in the short-term,but this study is the first I amaware of to demonstrate that the effect persists for years.5While estimates of the marginal propensity to consume vary in the literature,most researchers findthat it is high for permanent shocks to income.See Jappelli and Pistaferri(2010)for a review of theliterature.Changes in mortgage payments represent a transfer between borrowers and creditors,so thereare potentially offsetting consumption effects.However,most mortgage debt in the US(often packaged intomortgage backed securities)is held by commercial banks,the Federal Reserve,or institutional investors,allof whom presumably have a low marginal propensity to consume.4consumption would further increase the importance of the mortgage payment channel.Thestrength of the mortgage payment channel also provides an explanation for monetary pol-icys effect on consumption despite micro evidence suggesting a low intertemporal elasticityof substitution(see,e.g.,Best et al.,2020).The total estimated change in payments includes the effects on inframarginal borrowers,marginal borrowers,and existing ARMs(whose mortgagors do not need to engage in anynew originations to be affected).Additionally,households engaging in new borrowing mayoffset some of the effect of monetary policy on payments by making an intensive marginadjustment,i.e.reducing the size of their loans in the face of higher rates.To identify therelative importance of these channels,I estimate their magnitudes separately.Inframarginal borrowers are simple to model because,by definition,their borrowing deci-sions are exogenous to the rate shock.The magnitude of the inframarginal borrower channelcan therefore be straightforwardly estimated via a simple back-of-the-envelope calculation.Using the average origination volume and mortgage interest rate over the past 25 years,Icalculate that cutting rates by 7.4 basis points for three years should reduce aggregate mort-gage debt service by approximately$5.2 billion per annum.The effect builds linearly overtime so long as the lower rate is maintained,as each month a new cohort of inframarginalborrowers are affected while cohorts that previously got their loan continue to pay the lowerrate.Comparing this simple calculation to the total estimated change in payments,it seemsthat inframarginal borrowers are reponsible for just over half of the pass-through of monetarypolicy.In addition to the increased or decreased payments faced by these inframarginal borrow-ers,a rate shock can pull in or exclude marginal borrowers.The number of such borrowerscan be estimated by the responsiveness of origination volumes to rate shocksthe differ-ence between this estimated number and the total number of originations is the numberof inframarginal borrowers.Marginal borrowers are vastly outnumbered by inframarginalborrowers for rate shocks of a typical historical magnitude,but the effect on their paymentsper-borrower may be much larger.This is because,for marginal borrowers,the counterfactualpayment is their current existing payment(with its old rate potentially very different from5current rates),not the payment they would get originating the same loan with a marginallydifferent rate(as it would be for inframarginal borrowers).6To determine the magnitude of the marginal refinance channel,I estimate the effect of thesame monetary policy shock on the number of weekly refinance originations over the 1999-2023 period.Again using a local projections estimator,I find the shock decreases refinancingvolumes by 3.5 percent over the three years post-shock,suggesting approximately$2 billionof the total increase in payments comes from marginal refinancers.For the marginal homepurchase channel,I run the same estimator on the number of weekly home purchase origi-nations.I do not find effects on home purchase lending volumes that are either statisticallysignificant or economically consequential for average payment amounts.To determine the magnitude of the ARM channel,I use a monthly panel of servicingrecords of individual ARMs from 2000 through 2023.The local projections estimator indi-cates that the same monetary policy shock increases ARM payments by approximately 1.2percent,equivalent to$2 billion in additional payments per year.The back-of-the-envelope calculation of the inframarginal borrower channel ignores thepossibility that households adjust on other margins(i.e.,loan size).To test this implicitassumption,I next estimate the magnitudes of the intensive margin channel.To do so,I run the local projections estimator on a weekly series of the average loan size of neworiginations.I find effects that are close to zero for the first few years after the shock.Theassumption of no intensive-margin adjustment used in the back-of-the-envelope calculationof the inframarginal channel appears benign.Together,the estimated magnitudes of the inframarginal borrower,marginal refinancer,and ARM channels add up to be close to the estimated net effect on aggregate payments.The estimates of channel-specific magnitudes use outco