Abstract
Maintenance and improvements affect house values and thus the observed pecuniary return. Whether due to lack of liquidity or the presence of strategic incentives, some borrowers have a higher probability of default and this could lead to lower maintenance and investment in the property. We test this hypothesis using a sample of properties on which we have repeat sales and mortgage information. We find that the predicted probability of default at the time of the original purchase significantly reduces subsequent observed pecuniary return. For instance, an increase in the probability of default from 22% to 32% leads to an 0.5% reduction in appreciation per year. Because the future house price varies with borrower risk, we examine many simulated scenarios to analyze the implications of the findings. From these scenarios, we observe that the highest risk borrowers can experience approximately 3% less appreciation per year than the lowest risk borrowers.
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Notes
In general, the true pecuniary return to the homeowner, which includes costs, may deviate greatly from the appreciation, which ignores costs. Moreover, a house tends to decline in price in the absence of improvements and maintenance. For example, Harding et al. (2007) estimated that without maintenance the price of a house tends to fall by 2.5% per year.
The “after-acquired mortgage clause” gives lenders a claim on property or improvements even if they occur after the inception of the mortgage (Arnold 1959).
When estimating the probability of default training model we also include origination years 2000 and 2001 to take advantage of our available mortgage data.
Of course, 90 day delinquency and foreclosure are closely related, but the difficulties of using foreclosures with their highly variable delays has led most empirical studies to use 90 day delinquency as the most operational empirical proxy.
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We thank the editors and referee for helpful comments. Hayunga gratefully acknowledges financial support from the Terry-Sanford Research Award.
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Hayunga, D.K., Pace, R.K. & Zhu, S. Borrower Risk and Housing Price Appreciation. J Real Estate Finan Econ 58, 544–566 (2019). https://doi.org/10.1007/s11146-018-9669-9
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DOI: https://doi.org/10.1007/s11146-018-9669-9