How Do Mortgage Rate Resets Affect Consumer Spending and Debt Repayment? Evidence from Canadian Consumers

We study the causal effect of mortgage rate changes on consumer spending, debt repayment, and defaults during an expansionary and a contractionary monetary policy episode in Canada. Our identification takes advantage of the fact that the interest rates of short-term fixed-rate mortgages (the dominant product in Canada’s mortgage market) have to be reset according to the prevailing market interest rates at predetermined time intervals. Our empirical strategy exploits this exogenous variation in the timing of mortgage rate resets. We find asymmetric responses of consumer durable spending, deleveraging, and defaults. These results can be rationalized by the cash-flow effect in conjunction with changes in consumers’ expectations about future interest rates. Our findings help us to understand the responses of the household sector to changes in the interest rate, especially in countries where variable-rate, adjustable-rate, and short-term fixed-rate mortgages are prevalent.