At such a point they have two channels for default: file for bankruptcy or go into mortgage foreclosure (short sales are also an option in our model, as described below). With uninsurable idiosyncratic earnings shocks and systemic house price shocks, homeowners can find themselves in unforeseen financial difficulties. We solve a dynamic model of a household that can purchase a house with a mortgage or continue renting and must simultaneously decide how much to consume and borrow from credit cards in each period. This paper applies a new heterogeneous agent dynamic model of rational utility-maximizing households to study the impact of two common credit policy levers (down payments and the credit exclusionary period) on both mortgage defaults and personal bankruptcy filings. Second, one policy effects home buyers before the home purchase while the other becomes relevant after the purchase and, then, only if the borrower begins to experience financial distress. First, both can be and have been varied and are within control of the government policy makers for at least the most part. These two policies are of particular interest for two reasons. In this paper we look at the efficacy of two potential policy levers: the size of down payment required and the length of time someone who defaults on his mortgage is subsequently excluded from the credit markets. Specifically, can we implement policies that reduce residential mortgage defaults in the future, thus lowering the risk of another financial crisis? The tremendous economic and social devastation wrought by the mortgage crisis highlights the importance of understanding the impact that policy levers have on household behavior as it relates to foreclosures and bankruptcy during a house price bust period. As the real estate market remained depressed and the financial sector struggled to work through the credit crunch magnified by the bursting of the housing bubble, 2010 alone saw more than 1 million houses enter foreclosure and 1.5 million households file for bankruptcy. banking system suffered greatly from the substantial number of mortgage foreclosures and household bankruptcies that arose due to the housing downturn that began in 2005. Thanks to concentrated investments in real estate, the U.S. The 2007–2009 recession was at least partially caused by a major contraction in the housing sector and a significant increase in mortgage delinquency and default rates.
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