Underwater Homeowners Cut Back Significantly On Other Spending

Underwater mortgages aren’t just causing families to make tough financial choices. A crucial revision to a paper on mortgage debt finds that being underwater on a mortgage has a direct impact on consumer spending. As Zachary A. Goldfarb explains, the paper found that in areas where more than half of the homeowners were underwater, they cut back significantly on their spending:

The authors found that being underwater makes a big difference…Zip codes with fewer than 15 percent of homeowners only cut back only a little – spending only half a cent less for every dollar their home fell in value. But in Zip codes where more than 50 percent of homeowners were underwater, borrowers cut back five times as much – spending 2.5 cents less on car purchases for each dollar of reduced housing wealth.

In an e-mail interview, Sufi says he and his co-authors believe the paper is the first to show that borrowers with very high leverage – which would include people who are underwater – are likely to cut back significantly on spending in a housing decline.

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This problem doesn’t just have big ramifications for borrowers and their communities. Reduced consumer spending has held back the entire recovery. Other research has found that underwater mortgage debt has been a big economic drag, as the areas that have high mortgage debt also have lower consumption and higher unemployment.

There are some tools to deal with this problem, and the authors of the revised paper suggest that mortgage write-downs could have been very important. “Facilitating mortgage debt write-downs would have softened the blow to household spending,” Amir Sufi wrote Goldfarb in an email. “A dollar lost by a creditor has less of a negative effect on consumption than the positive effect on consumption from a dollar gained by an underwater homeowner.” If consumption were higher, the rest of the economy would likely be doing better as well. A past report found that banks writing down all underwater mortgages to market value and refinancing to a 30-year mortgage would put $71 billion into the economy, creating over a million jobs.

By Bryce Covert

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