Default, Mortgage Standards and Housing Liquidity (with Allen Head, Queen’s University and Chenggang Zhou, University of Waterloo)

Amy Sun | Queen’s University

The influence of households’ indebtedness on their house-selling decisions is studied in a tractable dynamic general equilibrium model with housing market search and defaultable long-term mortgages.  In equilibrium, sellers’ behaviour varies significantly with their indebtedness.  Specifically, both asking prices and time-to-sell increase with the relative size of sellers’ outstanding mortgages.  In turn, the liquidity of the housing market associated with equilibrium time-to-sell determines the mortgage standards offered by competitive banks.  When calibrated to the U.S. economy the model generates, as observed, negative correlations over time between both house prices and time-to-sell with downpayment ratios.