Housing prices and borrowing are clearly linked. Princeton’s Atif Mian and Chicago Booth’s Amir Sufi have argued that the housing run-up in the early 2000s led US homeowners to borrow and buy more as they tapped the rising equity in their homes—and that the subsequent housing bust led to a sharp cut in spending.

Data from the UK mortgage market support the notion that house prices drive borrowing, according to University of California at Davis’s James Cloyne, Chicago Booth’s Kilian Huber, London School of Economics’ Ethan Ilzetzki, and Princeton’s Henrik Kleven.

To establish a causal relationship between house prices and borrowing, the researchers looked for a setting where changes in house prices were unrelated to factors that influenced borrowing. They found it in the United Kingdom, where housing is financed differently than it is in the United States. While most US homeowners take out long-term mortgages at fixed interest rates, almost all UK homeowners take out mortgages whose initial interest rates last only a few years, after which point the rates may rise. UK homeowners then tend to refinance after just a few years. This means that in the UK, households refinance at different times, not en masse when interest rates fall.

Cloyne, Huber, Ilzetzki, and Kleven analyzed UK housing data between 2005 and 2015, a decade with large housing-price swings. When house prices rose, it affected the amount of mortgage debt that homeowners took on, they find. A 10 percent rise in housing prices typically led to a 2–3 percent rise in equity extracted from a home through borrowing.

The tendency to increase borrowing was constant across homeowner characteristics, including homeowner age, income level, and income-growth level. An exception was homeowners who had low loan-to-value (LTV) ratios, who tended to resist borrowing more, even as their homes rose in value.

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The increase in borrowing was primarily due to the collateral effect of the rise in housing prices, the researchers argue. This means that homeowners were able to borrow more because they used their homes as collateral with lenders.

Interest rates changed as the LTV ratios changed, and this played an important role in homeowners’ borrowing patterns. When house-price increases moved homeowners to a lower interest rate, homeowners were more likely to up their borrowing.

Furthermore, homeowners tended to cluster at the round LTV ratios of 60, 70, 75, 80, and 85 percent, because in the UK, interest rates jump up discontinuously at these round ratios. Say a homeowner had an LTV ratio of 80 percent, which dropped to 76 percent as home prices rose. The homeowner would tend to increase her borrowing to return the LTV ratio to 80 percent.

However, when housing prices fall, borrowers can end up underwater. Says Huber, “That’s the main worry, and that’s what probably contributed to the Great Recession.”

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