Regional Variation in Transaction Costs, Mortgage Rate Heterogeneity, and Mortgage Refinancing Behavior

Recent work has demonstrated that the U.S. mortgage market is characterized by significant heterogeneity in the interest rates that are offered to borrowers as well as mortgage refinancing behavior. In this study we contribute to the mortgage heterogeneity literature by providing the first systematic analysis of regional differences in transaction costs in the mortgage market. Using the Uniform Closing Database—a unique repository of loan-level closing cost information—we demonstrate that there is a tremendous amount of regional variation in transaction costs in the mortgage market, most of which is driven by differences in local mortgage stamp taxes and recording fees.

In the second part of our paper, we take up the question of how failing to account for such heterogeneity might affect studies of borrower behavior in the mortgage market. We do so through the lens of the failure-to-refinance literature on optimal refinancing activity. Accounting for rate and closing cost heterogeneity significantly reduces estimates of suboptimal refinancing behavior, particularly among borrowers with high-risk credit profiles and those living in states with high closing costs. Because regional variation in closing costs is driven by the state and municipal policies, our results suggest that local governments play a role in the pass through of monetary policy via the mortgage market that has not been previously documented. Our findings also provide a potential mechanism above and beyond the home equity channel that could explain regional variation in refinancing activity and consumer spending during recoveries.