Why do households re-leverage as house prices rise?
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Guest Speaker: Peter Levell, Institute for Fiscal Studies
House price increases in many countries were accompanied by significant increases in household debt in the years prior to the financial crisis. In this paper, we examine the borrowing, spending and investment decisions of existing homeowners in response to house price increases. We show using panel data that homeowners re-levered as house prices rose and that the self-reported use of new mortgage loans was for home improvements and other residential investments rather than consumption. In addition we find that households that were initially more levered are more likely to both purchase other residential properties and invest in their own homes in response to local house price increases than other households. However, these households do not disproportionately increase their consumption spending as house prices rise, as would be expected if re-leveraging behaviour were driven by traditional housing wealth effects. We show how these patterns of behaviour can be rationalised in a framework where households treat leverage as a portfolio choice, choosing leverage to optimise the risk and return on their assets. Households respond to house price increases by borrowing and investing in housing (including their own homes) in order to maintain their desired loan-to-value ratios.
Peter Levell is a Senior Research Economist at the Institute for Fiscal Studies in London and a part-time PhD student at University College London. His work focuses on understanding the spending and labour supply decisions of individual households. He has also written on the measurement and impact of inflation and is a member of the Office for National Statistics Technical Advisory Panel on Consumer Prices.