Academic journal article Federal Reserve Bank of New York Economic Policy Review

Tracking and Stress-Testing U.S. Household Leverage

Academic journal article Federal Reserve Bank of New York Economic Policy Review

Tracking and Stress-Testing U.S. Household Leverage

Article excerpt

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High household debt is widely considered one of the main causes of the Great Recession and the slow recovery that followed. Over the first half of the 2000s, U.S. household debt, particularly mortgage debt, rose rapidly along with house prices, leaving consumers very vulnerable to house price declines. Indeed, as house prices fell nationwide from 2007 to 2010 and unemployment rates soared, mortgage defaults and foreclosures skyrocketed because many households were "underwater," meaning the outstanding amount of their home loans exceeded the then-current value of their properties (see Chart 1). To assess the risk of a reoccurrence of this scenario (or of a similar event taking place) in the future, and to guard against such an event, it is crucial to track household leverage, especially on home loans (first-lien mortgages as well as home equity loans and lines of credit). Furthermore, it is imperative to consider homeowner leverage not only at the current level of house prices but also under realistic scenarios involving negative house price shocks. In this article, we combine different data sets to track and stress-test the leverage of U.S. homeowners in a representative way.

The primary source of information used in our analysis is a newly available data set, Equifax's Credit Risk Insight Servicing McDash (CRISM), which combines the mortgage-servicing records of about two-thirds of outstanding U.S. first-lien mortgages (the McDash component1) with credit record information on the respective mortgage holders (from Equifax). The credit record component allows us to observe second liens (home equity loans and lines of credit) likely associated with a first mortgage, so that we can construct an updated combined loan-to-value (CLTV) ratio for properties with a first mortgage in our sample. Such a calculation is typically impossible using mortgage servicing data alone, because there is no way to connect second liens with first liens on the same property. We also observe borrowers' updated FICO credit scores, giving us a further dimension along which to evaluate potential default risk. Since the CRISM sample does not cover the full population of U.S. mortgages, we ensure its representativeness by weighting observations based on the distribution of loan characteristics in the New York Fed Consumer Credit Panel (CCP), which tracks the credit records of a representative sample of the U.S. population.2

We use the resulting CLTV estimates to document the changing pattern of U.S. homeowners' leverage over the last ten years, both nationwide and across regions. In addition to showing average CLTVs, we focus in particular on the fraction of properties with CLTVs exceeding 80 percent or 100 percent. We also quantify the strong relationship between CLTVs and the rate at which borrowers become seriously delinquent (meaning they are behind on their mortgage payments by ninety days or more). Furthermore, we assess what would happen to CLTVs and delinquency rates under a variety of more- or less-severe shocks to local house prices, with those shocks reflecting either a reversal of recent growth rates or a repetition of the drop in house prices that occurred during the 2007-10 bust. This analysis thus provides an early warning indicator of risks to the financial system emanating from housing finance, and it is therefore related to the stress-testing of banks (for instance, the Federal Reserve's Comprehensive Capital Analysis and Review, or CCAR), though our analysis is conducted at the property level (and then aggregated to regional and national levels) rather than at the lender level.3

Our key findings are the following: As of the first quarter of 2017, nationwide, household leverage has declined substantially compared with 2008-12 and is approaching pre-crisis levels. Consequently, and also because of an improvement in credit scores among households with outstanding mortgages, the household sector's vulnerability to a modest decline in house prices has decreased. …

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