Financial Skills and Search in the Mortgage Market

Abstract

This paper examines how financial literacy shapes households' mortgage decisions through a structural model of mortgage search. Using a unique U.S. dataset that integrates detailed mortgage information with objective measures of financial literacy, we find that households with lower financial literacy are 4% less likely to engage in mortgage search and end up locking in at 33 basis points higher mortgage rates. Moreover, they are 5.1 p.p. less likely to refinance, which defines a lower bound of $575 in annual mortgage overpayments. To explore the impact of financial skills and search behavior on mortgage rate outcomes, we develop a mortgage search model that incorporates endogenous financial skill accumulation and heterogeneous search frictions. Our results show that: (i) greater mortgage access increases delinquency risks for less financially skilled households, (ii) targeted financial education can help reduce these risks, and (iii) low mortgage rates primarily benefit financially literate households through refinancing, ultimately contributing to greater consumption inequality. Finally, we find that easier mortgage access, driven by advances in search tools and increased information availability, reinforces financial skill accumulation, suggesting that targeted policies may be more effective today than in the past. (withe Ante Sterc, Banco de Portugal & Nova SBE)