The Consequences of Interest Only Loans for the Housing Boom and Bust

We use a natural experiment in Denmark to assess the impact of interest-only (IO) mortgages during the 2000s. Our results indicate that IO mortgages amplified the boom-bust pattern in housing: IO loan availability caused house prices to increase 35 percent during the boom and then subsequently reverse during the bust. These effects, which cannot be explained by changes in lending standards or credit supply, are magnified in more inelastic housing markets and have a large impact on the real economy. Together, findings are consistent with households using IO loans to capitalize on optimistic house price expectations during the 2000s boom.