House price appreciation, liquidity constraints, and second mortgages

This paper analyzes how households use second mortgages in response to shocks to housing wealth. Two related questions are examined: Do households use home equity in response to house price appreciation? Are liquidity constraints important for homeowners? A theoretical model shows that liquidity-constrained households respond more strongly to house price changes than unconstrained households. Using PSID, I find noteworthy differences in borrowing patterns of homeowners by the ratio of wealth to income. Low wealth-to-income homeowners exhibit a strong reaction to house price appreciation, whereas high wealth-to-income ones do not. The results indicate the importance of liquidity constraints among homeowners.