Leverage and the Foreclosure Crisis

Abstract

How much of the foreclosure crisis can be explained by the large number of high-leverage mortgages originated during the housing boom? In our model, heterogeneous households select from mortgages with different down payments and choose whether to default given income and housing shocks. The use of low–down payment loans is initially limited by payment-to-income requirements but becomes unrestricted during the boom. The model approximates key housing and mortgage market facts before and after the crisis. A counterfactual experiment suggests that the increased number of high-leverage loans originated prior to the crisis can explain over 60 percent of the rise in foreclosure rates.

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