Equity Extraction and Mortgage Default

63 Pages Posted: 25 May 2013

See all articles by Steven Laufer

Steven Laufer

Board of Governors of the Federal Reserve System

Date Written: March 21, 2013


Using a property-level data set of houses in Los Angeles County, I estimate that 30% of the recent surge in mortgage defaults is attributable to early home-buyers who would not have defaulted had they not borrowed against the rising value of their homes during the boom. I develop and estimate a structural model capable of explaining the patterns of both equity extraction and default observed among this group of homeowners. In the model, most of these defaults are attributable to the high loan-to-value ratios generated by this additional borrowing combined with the expectation that house prices would continue to decline. Only 30% are the result of income shocks and liquidity constraints. I use this model to analyze a policy that limits the maximum size of cash-out refinances to 80% of the current house value. I find that this restriction would reduce house prices by 14% and defaults by 28%. Despite the reduced borrowing opportunities, the welfare gain from this policy for new homeowners is equivalent to 3.2% of consumption because of their ability to purchase houses at lower prices.

Keywords: Household finance, mortgages, equity extraction, default

JEL Classification: D14, G21, G33, E20, R20

Suggested Citation

Laufer, Steven, Equity Extraction and Mortgage Default (March 21, 2013). FEDS Working Paper No. 2013-30. Available at SSRN: https://ssrn.com/abstract=2269075 or http://dx.doi.org/10.2139/ssrn.2269075

Steven Laufer (Contact Author)

Board of Governors of the Federal Reserve System ( email )

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