Reference no: EM132126376

Question: TREATMENT OF MORTGAGE PAYMENTS

For many families, their biggest monthly cost is the mortgage payment, so it would seem to be a very important part of consumption. However, that raises several methodological issues in the NIPA. For one thing, some proportion of the mortgage payment represents the reduction of principal; since no new good or service is being created, and no factor payments flow to anyone, that would not be part of GDP. By the same token, if someone pays off their mortgage entirely, GDP should not decline just because the mortgage payments stop, since that certainly does not mean GDP has decreased. Similarly, if someone takes out a second mortgage, that should not boost GDP. Because of these reasons, mortgage payments are treated quite differently than other consumer purchases in the NIPA. Instead of recording the amount actually paid each month, government statisticians estimate how much the homeowner would receive each month if the house were rented to someone else. That is the amount entered in ‘‘consumption of housing services,'' and is independent of the size of the mortgage, the current interest rate being charged, or whether it is a new, old, or nonexistent mortgage. This is not a trivial point, and one we will revisit when examining the determinants of consumption. Consider the case of someone with a variable rate mortgage, and the rate rises from (say) 6% to 8%. The mortgage payment will rise accordingly, leaving less money to spend on other goods and services. As a result, there will be an ex ante decline in aggregate demand even though aggregate income has not changed.4 Now suppose the mortgage rate falls from 8% to 6%, and the homeowner refinances at the lower rate. He now has more money to spend on other goods and services, so in a significant sense, real income has risen. However, no such entry appears in the NIPA. As a result, when interest rates fall, the reported personal saving rate has declined. That is another reason why the BEA measure of personal saving dropped so much during the 1990s, when many homeowners refinanced their mortgages at lower rates.