Two Essays on Real Estate Finance: 1) Effects of FHA Loan Limit Increases by ESA 2008: Housing Demand and Adverse Selection; and 2) Comparison of Two Affordable Housing Finance Channels Open Access
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Essay1: Effects of FHA loan limit Increases by ESA 2008:Housing Demand and Adverse SelectionThis paper examines the impacts of changes in the Federal Housing Administration (FHA) insured loan limit in response to the Economic Stimulus Act (ESA) of 2008. We use difference-in-difference approaches to compare the number of transactions and average loan-to-value ratios for properties located in high-cost areas and low-cost areas, before and after the ESA policy change. We find that the increase in loan limits does result larger demand for FHA loans, both in quantity and quality. However, the behavior is not driven by incentives to buy more housing or by wealth constraints. We find evidence of increased moral hazard in the sense that increased loan limits induced riskier borrowers (allowed “cherry-picking” against FHA), and that much of the increased demand for FHA loans came at the expense of other loans. For instance, newly qualified borrowers, especially via cash-out refinance loans, are more likely to take advantage of increased loan limit policy, and adjust their LTVs. Also newly qualified loans had higher default rates and higher loss given default rate. Essay 2: Comparison of Two Affordable Housing Finance ChannelsThis paper theoretically and empirically demonstrates that mortgage with shared equity structure is a better affordable housing solution than high-leverage lending, in terms of default reduction. In equilibrium market, the effectiveness of strategic defaults reduction is shown stronger when shared equity contracts are conducted in expensive house price areas or housing bubble periods, or with long holding terms, or borrowers with high expected return. In the meanwhile, through numerical examples using simulation and back-testing techniques, we show homeowners in Los Angles could avoid strategic defaults in the recent recession if they use shared equity structure mortgage as an alternative to traditional low down-payment mortgage.