But during the crisis, many borrowers were unable to refinance either because their property was worth less than the outstanding mortgage balance, or because they didn’t otherwise fulfill underwriting criteria that had also become much more stringent than during the boom. These features surely limited the transmission of accommodative monetary policy through households’ balance sheets. Furthermore, borrowers that were able to refinance and benefit from lower interest rates were mostly those with high credit scores and relatively lower debt balances. The Administration responded to this limited pass-through by introducing programs such as the Home Affordable Refinance Program, or HARP, to enable refinancing for borrowers with high-LTV loans backed by Fannie Mae or Freddie Mac, or facilitating streamline refinances of FHA loans. While these programs eventually reached a large number of borrowers, their implementation was complex. As a simple mortgage design counterfactual, had more borrowers had adjustable-rate mortgages, which are generally indexed to short-term interest rates, the pass-through of lower market interest rates would have been more direct. As the Chart illustrates, the average interest rate on outstanding ARMs declined more rapidly than the rate on FRMs, even though in the U.S. most ARMs only adjust after a rather long fixed-rate period (often 5 or more years) and then only do so infrequently (generally once or twice a year). Crucially, ARM interest rate resets reduced mortgage payments without requiring the borrower to refinance, thereby benefiting a broad range of borrowers, including those with little or no home equity and/or low credit scores.

5  This is also an implication of the model presented in Auclert, 2015, Monetary Policy and the Redistribution Channel. 2  BIS central bankers’ speeches  A related consideration is that refinancing to a lower interest rate requires significant resource costs, which would not be incurred if the borrower’s interest rate adjusts automatically when market interest rates decline. One estimate of the cost of refinancing a mortgage, which includes costs such as those on a property appraisal or title insurance, is $ plus one percent of the loan amount. 6 Under this estimate, total refinancing transaction costs over 2008–2013 exceeded $ billion. 7 Furthermore, the re-underwriting of existing loans leads to resource constraints in the mortgage origination industry during refinancing waves, frequently followed by lay-offs when the refinancing boom is complete. 8 Timing a mortgage refinancing optimally also requires time and attention from the borrower, and can lead to refinancing mistakes, particularly by less financially sophisticated households. 9 But do these considerations make ARMs preferable to FRMs, either from the point of view of monetary policymakers, or public policy more generally? Not necessarily. FRMs have many advantages; for example they are simple for borrowers to understand, and clearly limit household exposure to interest rate volatility. Consider too the incidence of interest rate adjustments: widespread reliance on ARMs may have unattractive distributional consequences for monetary policy, since it implies that a larger component of monetary transmission falls on a subset of highly indebted mortgage borrowers.