Home is Where the Equity Is: Liquidity Constraints, Refinancing and Consumption

It should be noted that even households who are relatively patient may choose to refinance and access home equity if the …

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Home is Where the Equity Is: Liquidity Constraints, Refinancing and Consumption
Erik Hurst
Graduate School of Business
University of Chicago
Chicago, Illinois 60637
and
Frank Stafford
Department of Economics

This paper documents the extent to which homeowners use housing equity to smooth their marginal utility of consumption over time. Unlike drawing down other forms of saving, accessing accumulated home equity can be quite costly. As a result, households accumulating home equity could be liquidity constrained in the sense that they would like to access this equity to fund consumption but are unwilling to pay the costs to do so. Theoretically and empirically, a key distinction can be drawn between those refinancing their home mortgage to improve their wealth position from those who had a consumption smoothing motivation to refinance. Incorporating characteristics of a mortgage into a traditional permanent income model with exogenous liquidity constraints, one can understand household refinancing behavior in a world where mortgage interest rates are historically high and rising – up to now, an empirical puzzle.

Download Home is Where the Equity Is: Liquidity Constraints, Refinancing and Consumption pdf from faculty.chicagobooth.edu, 48 pages, 304.97KB.
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