Henrik Kleven, London School of Economics

"The Effect of House Prices on Household Borrowing: A New Approach"

Abstract

A large literature estimates the effect of house prices on household borrowing using aggregate or regional house price variation, raising concerns that confounding macroeconomic or regional factors may bias the results. We revisit this classic question using administrative mortgage data from the UK, which contains household-level information on house prices and borrowing in a panel of homeowners who refinance at regular, quasi-exogenous intervals.

The panel structure of the data allows us to absorb fixed effects that deal with the key confounders discussed in the literature. In our preferred specification, the identifying house price variation is driven by the timing of refinance events, which is governed by past mortgage contract choices. We present two main results. First, there is a clear and robust effect of house prices on borrowing. However, the elasticity that we estimate is considerably smaller than recent U.S. estimates.

Second, the effect of house prices can be explained largely by collateral effects. Our main test exploits the presence of interest rate notches that depend on collateral, implying that house price growth relaxes credit constraints (reduces marginal borrowing costs) to the extent that it pulls homeowners below interest rate notches. We show that the borrowing elasticity is much larger when the underlying price variation relaxes credit constraints in this way and conversely that the elasticity is zero when credit constraints are reinforced.