Welfare Analysis of Housing in the Presence of Interest Rate Risk

We model the welfare losses of (i) the presence of a mortgage with required repayments, (ii) a minimum pension savings constraint, and (iii) imposing a suboptimal investment strategy. We develop a life-cycle model which considers housing and interest rate risk. For a reasonable set of parameter values, we find welfare losses of up to 2:41% (5:02%) if a homeowner with a 30-year fixed-rate (adjustable-rate) mortgage faces a minimum savings constraint of 10%. These welfare losses increase sharply if a homeowner is obliged to save an even higher percentage to the retirement account. Moreover, we find sizeable welfare losses when imposing the investment strategy of a homeowner with a mortgage on a homeowner without a mortgage.