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Household leverage

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  • Corradin, Stefano

Abstract

I propose a life-cycle model where a finitely lived risk averse agent finances her housing investment choosing to provide a down payment. After signing the mortgage contract, the agent may strategically default and move into the rental market. Risk neutral lenders efficiently price mortgages charging a default premium to compensate themselves for expected losses due to default on a mortgage. As a result, mortgage value and amount of leverage are closely linked. An alternative is for the agent to rent the same house, paying a rent fully adjustable to house prices. The rent risk premium is set such that the agent is indifferent ex ante between owning with a mortgage and renting. Three main results arise. First, the optimal down payment and the house price volatility are positively related. The higher the house price volatility, the higher the down payment the agent provides to decrease the volatility of the equity share in the house. Second, in the presence of borrowing constraints, a higher risk of unemployment persistence and/or a substantial drop in labor income decreases the leveraged position the agent takes. Third, ruling out the effect of taking costly leverage on owning a house significantly biases the results in favor of owning over renting. JEL Classification: G21, E21

Suggested Citation

  • Corradin, Stefano, 2012. "Household leverage," Working Paper Series 1452, European Central Bank.
  • Handle: RePEc:ecb:ecbwps:20121452
    Note: 1103497
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    File URL: https://www.ecb.europa.eu//pub/pdf/scpwps/ecbwp1452.pdf
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    References listed on IDEAS

    as
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    Cited by:

    1. Hartmann, Philipp, 2015. "Real estate markets and macroprudential policy in Europe," Working Paper Series 1796, European Central Bank.
    2. Thomas Schelkle, 2018. "Mortgage Default during the U.S. Mortgage Crisis," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 50(6), pages 1101-1137, September.
    3. John Y. Campbell & João F. Cocco, 2015. "A Model of Mortgage Default," Journal of Finance, American Finance Association, vol. 70(4), pages 1495-1554, August.
    4. Mavropoulos, Antonios & Xiong, Qizhou, 2019. "Housing consumption and macroprudential policies in Europe: An ex ante evaluation," IWH Discussion Papers 17/2018, Halle Institute for Economic Research (IWH).
    5. Jansson, Thomas, 2017. "Housing choices and labor income risk," Journal of Urban Economics, Elsevier, vol. 99(C), pages 107-119.
    6. Christopher L. Foote & Lara Loewenstein & Paul S. Willen, 2018. "Technological Innovation in Mortgage Underwriting and the Growth in Credit: 1985-2015," Working Papers (Old Series) 1816, Federal Reserve Bank of Cleveland.
    7. Sheridan Titman & Ko Wang & Jing Yang, 2014. "The Dynamics of Housing Prices," NBER Working Papers 20418, National Bureau of Economic Research, Inc.

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    More about this item

    Keywords

    Default premium; loan to income ratio and; loan to value ratio; negative home equity; rent risk premium;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth

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