Mortgage Debt Overhang: Reduced Investment by Homeowners with Negative Equity | Bedford Hills NY Homes

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 By Bryan Melzer
Kellogg School of Management, Northwestern University
 
Abstract:
Homeowners with negative equity have less incentive to invest in their property. They face a debt overhang: in expectation, some value created by equity investments in the property will go to the lender. Using rich microdata on household expenditures, I show that debt overhang plays an important role in household financial decisions. I find that homeowners with negative equity cut back substantially on mortgage principal payments, home improvements and home maintenance spending. At the same time, these households show no difference in durable spending on automobiles, furniture and home appliances, investments that are not attached to the home. The decline in mortgage principal payments is particularly large for negative equity homeowners in non-recourse states, where strategic default is more likely because lenders have limited claim on non-housing wealth. Debt overhang, rather than financial constraints, best explains this set of facts. Given the prevalence of negative home equity in today’s housing market, the results suggest that home prices will grow more slowly in the future because of underinvestment. In addition, the potential deadweight loss due to home foreclosures is only part of the economic inefficiency that follows the spree of mortgage borrowing in the 2000s and the subsequent real estate price decline.
 
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via regionalhopi.org

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