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Equity Dilution: An Alternative Perspective on Mortgage Default

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  • Michael LaCour‐Little

Abstract

Empirical research on mortgage default in the single‐family market has focused on the value of the borrower's put option using house price indices to estimate contemporaneous loan‐to‐value ratio or the probability of negative equity. But since the borrower possesses the option to increase leverage by taking on additional debt secured by junior liens subsequent to loan origination (a phenomenon termed here equity dilution), even a perfect house price adjustment cannot be expected to accurately measure changes in borrower equity over time. Since junior liens are generally unobservable to senior debt holders, proxies are required in empirical applications. This paper employs an independent estimate of junior lien probability developed from the 1998 Survey of Consumer Finances combined with loan level mortgage performance data to examine the role junior liens play in increasing default risk.

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  • Michael LaCour‐Little, 2004. "Equity Dilution: An Alternative Perspective on Mortgage Default," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 32(3), pages 359-384, September.
    • Handle: RePEc:bla:reesec:v:32:y:2004:i:3:p:359-384
    DOI: 10.1111/j.1080-8620.2004.00095.x
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    Cited by:

    1. Marcus T. Allen & Justin D. Benefield & Christopher L. Cain & Norman Maynard, 2024. "Distressed Property Sales: Differences and Similarities Across Types of Distress," The Journal of Real Estate Finance and Economics, Springer, vol. 68(2), pages 318-353, February.
    2. William H. Rogers & William Winter, 2009. "The Impact of Foreclosures on Neighboring Housing Sales," Journal of Real Estate Research, American Real Estate Society, vol. 31(4), pages 455-480.
    3. LaCour-Little, Michael & Calhoun, Charles A. & Yu, Wei, 2011. "What role did piggyback lending play in the housing bubble and mortgage collapse?," Journal of Housing Economics, Elsevier, vol. 20(2), pages 81-100, June.
    4. Michael LaCour-Little & Wei Yu & Libo Sun, 2014. "The Role of Home Equity Lending in the Recent Mortgage Crisis," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 42(1), pages 153-189, March.
    5. Timothy Jones & Dean Gatzlaff & G. Stacy Sirmans, 2016. "Housing Market Dynamics: Disequilibrium, Mortgage Default, and Reverse Mortgages," The Journal of Real Estate Finance and Economics, Springer, vol. 53(3), pages 269-281, October.

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