Protecting homeowners from themselves
Andy Dean Photography
In the years leading up to the Great Recession, a home was more than a place to live: It was a seemingly bottomless piggy bank.
Homeowners became accustomed to tapping their ever growing equity to fund their children’s college education, home improvements, new cars, and other expenses to maintain a certain standard of living.
Then the bubble burst and the tap shut off, exposing homeowners to an even deeper cavity of negative equity than they would have experienced had they left their investment alone. It would drive many families into default.
A paper in the February issue of American Economic Journal: Economic Policy poses the question of whether setting limits on home equity loans would have made a difference.
Author Anil Kumar looked at data from Texas — the only state that limits home equity borrowing to 80 percent of the value — to examine whether limits on borrowing could have lowered the likelihood of default.
Figure 4 from Kumar (2017)
The figure above compares subprime mortgage default rates from 2007 to 2011 for counties on either side of the Texas border with other states. Kumar controls for differences in unemployment, the initial FICO scores, and changes in home prices. He finds a striking difference in the rate of default, with Texas homeowners much less likely to go into foreclosure than their cross-border neighbors.