Newswise — When natural disaster hits, the federal government offers low interest loans to help homeowners repair damage to their homes, and millions have taken advantage of the inexpensive money to get their lives back on track.
But a new study from the University of Iowa suggests many who qualify are surprisingly fickle when it comes to interest rates. It finds many people who qualify for a loan turn it down because they worry the rate is too high, even though it’s almost always lower than the market rate and cheaper than alternative funding sources.
“People are extremely sensitive to interest rates when they really shouldn’t be,” said Cameron Ellis, assistant professor of finance in the Tippie College of Business.
The study found that 28% of property owners who are eligible for the subsidized loans turn the loan down because they worry the interest rate is too high, even though the loans are below the market mortgage rate and usually a better option than such alternatives as credit cards or money from savings or retirement accounts.
It also found that 70% of those who accept the loans would not if they had to pay the going mortgage rate.
The study looked at loan activity following every natural disaster between 2005 and 2018, including the 2008 Iowa floods, hurricanes such as Katrina and Harvey, superstorm Sandy, numerous western wildfires, and the 2012 derecho that hit the East Coast. More than 1 million households applied for loans during the study period, and $12.5 billion was dispersed to more than 285,000 approved households.
Why did those 28 percent turn it down? Ellis said it might be caused by confusion because the information sheet is not always clear about the interest rate on the loan, or the homeowner may not yet know how much money they need to repair the damage.
But he said most of them said no because they felt the interest rate was too high, even though it was below the current mortgage rate. He said that for every 1% the loan rate increases, acceptance decreases by 26 percent.
“Households who would have to commit a larger share of their discretionary income to servicing the loan have lower willingness to pay,” he said. “Demand seems to be attenuated by households’ concerns regarding their monthly budget constraints and their access to substitutes, so the reach of recovery loans is limited by consumers’ sensitivity to funding rebuilding through long-term commitments on their cash flows.”
He said Congress will occasionally discuss eliminating the federal subsidy for the program as a cost cutting effort, but doing so will push the loan rates up and reduce participation in the program further. Ultimately, fewer participants puts more financial pressure on the homeowner, slows the pace of disaster recovery for the individual and the community, and puts other public relief programs under pressure.
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