House Price Beliefs And Mortgage Leverage Choice

Abstract

We study the relationship between homebuyers’ beliefs about future house price changes and their mortgage leverage choices. Whether more pessimistic homebuyers choose higher or lower leverage depends on their willingness and ability to reduce the size of their housing market investments. When households primarily maximize the levered return of their property investments, more pessimistic homebuyers reduce their leverage to purchase smaller houses. On the other hand, when considerations such as family size pin down the desired property size, pessimistic homebuyers reduce their financial exposure to the housing market by making smaller downpayments to buy similarly-sized homes. To determine which scenario better describes the data, we investigate the cross-sectional relationship between house price beliefs and mortgage leverage choices in the U.S. housing market. We use plausibly exogenous variation in house price beliefs to show that more pessimistic homebuyers make smaller downpayments and choose higher leverage, in particular in states where default costs are relatively low, as well as during periods when house prices are expected to fall on average. Our results highlight the important role of heterogeneous beliefs in explaining households’ financial decisions.

Five Facts About Beliefs and Portfolios

“…These results relate to the literature linking expectations to demographic characteristics and personal experiences. It is common in this literature to find strong statistical relationships but low explanatory power for expectations using variables such as wealth, gender, IQ, place of birth, current location, own past experience, or friends' past experiences (see, for example, Malmendier and Nagel, 2011;Kuchler and Zafar, 2015;Das, Kuhnen and Nagel, 2017;Bailey et al, 2017Bailey et al, , 2018Coibion, Gorodnichenko and Kamdar, 2018;D'Acunto et al, 2019). 48 Our results above highlight that the low R 2 s in these analyses is unlikely to be primarily due to classic measurement error in…”

“…Our work also relates to a literature that has explored the role of beliefs in other settings. For example, a number of papers have explored the role of individual expectations in the housing market (e.g., Piazzesi and Schneider, 2009;Case, Shiller and Thompson, 2012;Cheng, Raina and Xiong, 2014;Kuchler and Zafar, 2015;Burnside, Eichenbaum and Rebelo, 2016;Gao, Sockin and Xiong, 2016;Bailey et al, 2017Bailey et al, , 2018Glaeser and Nathanson, 2017;Adelino, Schoar and Severino, 2018a,b) as well as the role of firm expectations (e.g., Cummins, Hassett and Oliner, 2006;Bacchetta, Mertens and Van Wincoop, 2009;Coibion and Gorodnichenko, 2012;Gennaioli, Ma and Shleifer, 2016;Landier, Ma and Thesmar, 2017;Bachmann et al, 2018;Bordalo et al, 2018;Fuhrer, 2018). 6 A further related literature has explored how individuals with different political convictions respond differentially to political events, both in terms of their consumption (Mian, Sufi and Khoshkhou, 2015) as well as in terms of their portfolio allocations (Meeuwis et al, 2018).…”

“…This finding is closely related to the literature linking expectations to demographic characteristics and personal experiences. It is common in this literature to find strong statistical relationships but low explanatory power between expectations and variables such as wealth, gender, IQ, place of birth, current location, own past experience, or friends' past experiences (see, for example,Malmendier and Nagel, 2011;Kuchler and Zafar, 2015;Das, Kuhnen and Nagel, 2017;Bailey et al, 2017Bailey et al, , 2018Ben-David et al, 2018;Coibion, Gorodnichenko and Kamdar, 2018;D'Acunto et al, 2019). Also seeArmona, Fuster and Zafar (2016),Malmendier and Nagel (2015),Fuster, Perez-Truglia and Zafar (2018),and Laudenbach, Malmendier and Niessen-Ruenzi (2019) for other recent contributions to the study of expectation formation.…”

What Does Really Drive Consumer Confidence?

“…The PIP decreases sometime around the GFC, which means the HOME index performed worse during this period than the lagged values of consumer expenditure. This is not surprising given the growing body of literature that discusses the role of non-fundamental factors in explaining households' consumption behavior (Dees and Brinca 2013;Bailey et al 2017).…”

The Impact of Repossession Risk on Mortgage Default

“…Estimates of the sensitivity of defaults to these costs are important to address questions about how households make decisions about financial leverage (Bailey et al. (2018)), which ultimately can play a role in the both booms and busts of house price bubbles (Geanakoplos (2010)).…”