Understanding the Trade-Offs of Alternative Mortgage Products

Alternative mortgage products are commonly characterized by lower initial mortgage payments. As a consequence they may be a valuable tool for households who expect higher future labor income, and who wish to smooth consumption over the life-cycle. This paper proposes a test of this hypothesis, based on the permanent income theory; under this hypothesis mortgage type should help to predict future household labor income. We use almost two decades of United Kingdom household level panel data to implement this test, and find evidence supportive of the consumption smoothing hypothesis for the latter part of the sample period. The analysis provides valuable insights for those interested in mortgage markets reform and regulation.