NCPA - National Center for Policy Analysis

Recourse Mortgages Will Fix the Housing Market

January 23, 2013

When housing prices are rising, there is a small probability that housing loan defaults will occur because a borrower who cannot pay the mortgage will sell the house and pocket the difference due to the rising price of the house. But when housing prices are dropping, lenders are more likely to incur losses because borrowers become upside-down on their investment. The answer is making sure all mortgages are recourse mortgages, says Arnold Kling, a member of the Financial Markets Working Group at the Mercatus Center.

  • In recourse mortgages, which are common in Canada, lenders can continue to seek restitution even after all collateral against a loan has been seized.
  • If you have a $200,000 mortgage and the house is worth $150,000 when you default, under a recourse mortgage the lender is entitled to seek the remaining debt of $50,000.
  • The risk in home lending is due to fluctuating housing prices and is shared between the lender, the borrower and the taxpayer.

High down payments shift a majority of the risk to the borrower whereas high capital requirements shift a majority of the risk to the financial institution, which may be stuck covering the bill if the loan goes under. When down payments are low and lenders are not required to keep substantial capital on hand to guarantee loans, the taxpayer risks having to bailout a financial institution.

  • The bailouts during the bursting housing bubble were due to federal housing policies that directed financial institutions to lower down payment requirements.
  • Financial institutions were also allowed to keep low levels of capital, which created substantial leverage that encouraged risky lending.

According to Kling, recourse mortgages will shift risk from the financial institutions and the taxpayer toward the borrower, who will be ultimately responsible for the full cost of the loan. In addition to a transition away from non-recourse mortgages, requiring high down payments will stabilize the housing market and provide an extra barrier against predatory lending and housing price fluctuations.

Source: Arnold Kling, "Skin in the Housing Game," The American, January 14, 2013.


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