Financial Constraints, Inflated Home Prices, and Borrower Default during the Real-Estate Boom
During the housing boom, many subprime home buyers were not able to make a mort- gage down payment and therefore were at risk of being rationed from the market. To resolve the issue, some buyers, sellers and intermediaries artificially expanded the scope of transactions by including items that cannot be collateralized. As a result, observed house prices were higher and mortgages larger, ultimately relaxing buyers' financial constraints. I estimate that between 2005 and 2008, up to 16% of highly leveraged (greater than 95% loan-to-value) transactions in Cook County, Illinois were inflated (with prices higher by 6% to 15%). Inated transactions are more likely in low-income neighborhoods and when intermediaries have a high stake in the transaction. Although borrowers were twice as likely to default, their mortgage rates were not higher.
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