Houses as ATMs? Mortgage Refinancing and Macroeconomic Uncertainty

Abstract

We estimate a structural model of household liquidity management in the presence of long-term mortgages. Households face counter-cyclical idiosyncratic labor income uncertainty and borrowing constraints, which affect optimal choices of leverage, precautionary saving in liquid assets and illiquid home equity, debt repayment, mortgage refinancing, and default. Taking the observed historical path of house prices, aggregate income, and interest rates as given, the model quantitatively accounts for the run-up in household debt and consumption boom prior to the financial crisis, their subsequent collapse, and mild recovery following the Great Recession, especially among the most constrained households.

Keywords: mortgage refinancing, home equity, housing collateral, liquidity constraints, household consumption and saving decisions, leverage

JEL Classification: E21, E44, G2