House Prices, Home Equity-based Borrowing, and the U.S. Household Leverage Crisis

The average homeowner increases spending by between 25 and 30 cents for every dollar of home equity borrowing.

In House Prices, Home Equity-based Borrowing, and the U.S. Household Leverage Crisis (NBER Working Paper No. 15283) co-authors Atif Mian and Amir Sufi examine individual home equity appreciation and household borrowing decisions from 2002 to 2006 and their relationship to the subsequent rise in mortgage defaults from 2006 to 2008. They find that homeowner leverage played an important role in the financial and economic downturn of recent years.

This study analyzes a dataset provided by a national consumer credit bureau. The dataset consists of roughly 70,000 anonymous individual homeowner credit files from the end of 1997 through 2008. It includes samples from every major U.S. metropolitan statistical area.

The researchers find that between 2002 and 2007, the debt-to-income ratio for U.S. households roughly doubled, reaching its highest level in over 25 years. They estimate that home equity-based borrowing averaged 2.8 percent of GDP between 2002 and 2006, totaling $1.45 trillion. That home equity borrowing explains roughly one third of new defaults in the 2006-8 period.

The rapid expansion in household leverage was due in part to the strong, steady house price appreciation that had taken place since the late 1990s, and particularly since 2002, and by the ready availability of mortgage credit -- in particular to an increasingly risky set of new, first time home buyers. That group includes younger households, households with low credit scores, and households with high initial credit card utilization rates.

The authors estimate that the average homeowner increases spending by between 25 and 30 cents for every dollar of home equity borrowing. Much of the spending is directed to consumer goods and services and to home improvements.

Borrowing against rising home equity was accompanied by a relative decline in default rates from 2002 to 2006, especially for low-credit-score and high-credit-card-use homeowners. But when the overall default rates began to rise in 2006, the default rates of homeowners who experienced steep house price appreciation from 2002 to 2006 rose much faster than those of homeowners who had not experienced such appreciation. The rise in default rates was especially strong among low-credit-score and high-credit-card-use homeowners who borrowed most aggressively against rising home equity during the housing boom. Those same households also reduced their auto loans between 2006 and 2008, highlighting the link between homeowner leverage and the demand for consumer durable goods.

-- Frank Byrt