With unemployment sky rocketing as a result of Covid-19, there has been a corresponding rise in evictions and mortgage defaults. A new study from Washington University in St. Louis’ Olin Business School of the loan-to-value ratios in the wake of the 2008 financial crash issues a cautionary warning about the troubles ahead.
The study finds that the higher the outstanding mortgage is relative to the value of the home, the worse the future income growth and job mobility of the individual will be.
The researchers assessed wage data and credit profiles from around 30 million Americans working in over 5,000 companies. The analysis revealed a negative association between the income of the worker and their home loan-to-value (LTV) ratio, with this especially so when the principle owed was higher than the value of the house.
For instance, when homes were in such negative equity, the homeowner would earn $352, or 5%, less per month than workers with less mortgage debt relative to the value of their home. This situation is often compounded by poor credit or liquidity issues, which can render people unable to move to a new job with better income, or even to a new area. It’s a situation the researchers believe could be exacerbated by the current crisis.
“The impact of the current crisis on local economies varies widely across the U.S.,” the researchers say. “Our study highlights the difficulties someone in a worse-affected area may face in trying to pack up and move to a less-affected region. Furthermore, our study also highlights an important cost of homeownership: For instance, buying a home will constrain your labor mobility, and in the long run that may adversely affect your labor income.”
The researchers gathered data from Equifax and combined it with house-price data from Corelogic for a sample of around 300,000 workers who all have an active mortgage. The researchers were tracked over a 72-month period, and their home equity was measured as the unpaid mortgage versus the market value of their primary residence. They also tried to account for home-value increases and decreases in particular areas, and also to control for local economic conditions. What’s more, they also attempted to draw a contrast between the incomes of homeowners and renters, even if they worked at the same firm, were of a similar age, and had both a similar job tenure and income level.
The data revealed that homeowners with high LTV were significantly less likely to change homes, but significantly more likely to change jobs. Renters facing broadly similar circumstances experienced no such issues. This translated into slower income growth for those with high LTV compared to renters.
It wasn’t quite as straightforward as a pure rent/own situation, however, as the income and mobility of homeowners could vary significantly. For instance, an individual could face relatively small income declines, or they could find fantastic job opportunities if they lived in an area with more jobs available or that had fewer non-compete laws that limit movement within an industry. Nonetheless, they still discovered a link between house prices and employment prospects, such that the fall in house prices after the 2008 recession led to a 2.3% fall in wages due to constrained mobility.
“If the adverse effects of the current pandemic on local economic conditions also spill over to house prices, then we will find ourselves with a number of underwater homeowners,” the researchers explain. “In that scenario, the effects we document will be very relevant.”
For those people with negative equity in their property, if they were presented with a new job in a different area, they had one of three options:
- Sell their home for less than they paid and swallow the shortfall
- Retain the home and try and rent it out, which would impact any deposit they could put down on a home in their new region
- Walk away and default on the mortgage, with all of the credit rating implications
In other words, when mobility is hampered, it reduces the ability of people to look for better work opportunities, which has an obviously impact on their income potential.
“Our study highlights an important cost of home ownership,” the researchers explain. “While the “American dream’ is usually defined in terms of building wealth through home ownership, the financial crisis has revealed a few glaring holes in this story. Our study formally quantifies one important cost of following the “American Dream.” A relatively safe way to own a house is to make sure one has sufficient down payment or home equity so that even if house prices fall, one is not stuck with an underwater mortgage. To this extent, our study recommends caution in pushing mortgages with less down payment.”
It’s not yet clear quite what the impact of the seemingly inevitable coronavirus pandemic on either jobs or house prices, but the study provides a timely reminder that labor market mobility is highly prized in times of such economic uncertainty.