Using a granular database of variable rate euro area loans and analysing their defaults between 2014 and 2019, we show that the effect of interest rate changes on mortgage defaults is highly non-linear. First, we find that the risk associated with higher contemporaneous interest rates is concentrated among borrowers who got the loan at ultra-low interest rates, their default probability being 2.6 times higher than our sample average. Second, we show that the effect of interest rate changes on the default probability is asymmetric: interest rate cuts have rather small effects, whereas increases significantly raise default probabilities. Finally, we show that the magnitude of the effect of an interest rate increase depends on the history of net interest rate changes, with a consecutive interest rate increase having a 3 times stronger impact on the default probability than an increase following an interest rate decrease.
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