Deficiency Judgments and Borrower Maintenance: Theory and Evidence

It is well known that when property rights to an asset are divided, individual right holders may not have adequate incentives to invest in proper maintenance. In this paper, weexamine how mortgage laws affect the nature of the lender's claim to the house, and howthat claim in turn affects the incentives of borrowers to invest in home maintenance. Thespecific law that we examine concerns the right of lenders to pursue a borrower's nonhous-ingwealth in the event of default if the value of the house is less than the mortgage balance. Most states allow lenders to collect such “deficiency judgments,” while others either prohibit, or make it difficult to obtain them. The theoretical model developed inthis paper predicts that borrowers will maintain at a higher rate when lenders are allowedto seek deficiency judgments. Intuitively, when borrowers' nonhousing wealth is at risk,they have an incentive to invest more in maintenance in order to reduce the likelihood that the value of the property will fall below the mortgage balance. We attempt to measure this effect using data on household maintenance obtained from the American Housing Survey along with information on differences in mortgage laws across states. We estimate a three-equation simultaneous system relating maintenance expenditures, house value, and mortgage rates. The results provide confirmation that variation in mortgage laws affect homeowner maintenance in the manner predicted by the theory.