House Prices, Home Equity-Based Borrowing, and the U.S. Household Leverage Crisis

Abstract:     
Using individual-level data on homeowner debt and defaults from 1997 to 2008, we show that borrowing against the increase in home equity by existing homeowners is responsible for a significant fraction of both the sharp rise in U.S. household leverage from 2002 to 2006 and the increase in defaults from 2006 to 2008. Employing land topology-based housing supply elasticity as an instrument for house price growth, we estimate that the average homeowner extracts 25 to 30 cents for every dollar increase in home equity. Money extracted from increased home equity is not used to purchase new real estate or pay down high credit card debt, which suggests that real outlays (i.e., consumption or home improvement) are likely uses of borrowed funds. Home equity-based borrowing is stronger for younger households, households with low credit scores, and households with high initial credit card utilization rates. Homeowners in high house price appreciation areas experience a relative decline in default rates from 2002 to 2006 as they borrow heavily against their home equity, but experience very high default rates from 2006 to 2008. Our estimates suggest that home equity-based borrowing is equal to 2.8% of GDP every year from 2002 to 2006, and accounts for 34% of new defaults from 2006 to 2008.

Keywords: subprime, mortgage, home equity, household leverage, house prices, consumption, wealth effect

JEL Classifications: D12, E21, E23, R21

Working Paper Series