jmcb.12620 (Q1)

DOI: 10.1111/jmcb.
12620
JISEOB KIM
How Unsecured Credit Policies Influence Mortgage

and Unsecured Loan Defaults
Before the global financial crisis, the proportion of households defaulting on

the mortgage while remaining current on the unsecured loan was almost the
same as the proportion of households current on the mortgage but defaulting
on the unsecured loan. After the crisis, the former ratio became higher than
the latter. By using a heterogeneous agent model with the mortgage and the
unsecured loan, I examine how the order of defaults changed before and
after the crisis. I then analyze the impacts of unsecured credit policies on
households’ mortgage and unsecured loan defaults. My quantitative exercise
shows that both default rates can decrease as the cost for unsecured loan
defaults increases.
JEL codes: E21, E44, G01, K35, R21

Keywords: unsecured loan, mortgage, foreclosure, bankruptcy.
BEFORE THE GLOBAL FINANCIAL CRISIS, the proportion of house-

holds defaulting on the mortgage while remaining current on the unsecured loan was
almost the same as the proportion of households current on the mortgage but de-
faulting on the unsecured loan.1 During and after the crisis, the former ratio became
much higher than the latter (Komos et al. 2012). In this paper, I quantitatively analyze
how the order of defaults can be reversed before and after the crisis. Since the 2007
financial crisis was characterized by a sudden and deep decrease in house prices, it
I thank the editor Sanjay Chugh, two anonymous referees, and seminar participants at Yonsei University,
the Asian Meeting of the Econometric Society, and the 12th Joint Economics Symposium of Five Leading
East Asian Universities for helpful comments. This research was supported by the Yonsei University
Research Fund of 2018-22-0015.
JISEOB KIM is an Assistant professor, School of Economics, Yonsei University (E-mail:
jiseob.kim@yonsei.ac.kr).
Received June 18, 2018; and accepted in revised form January 10, 2019.
1. Among many types of household debts, such as mortgages, credit card debts, education loans, auto
loans, lines of credit, and other loans secured by insurance or pension, I mainly focus on mortgages and
unsecured loans. According to the 2007 Survey of Consumer Finances, 29% of households held both
loans simultaneously. Here, the mortgage loan is the value of debt secured by the primary residence. The
unsecured loan is defined by the debt without the need for collateral, such as credit card loans and lines of
credit not secured by homes.
Journal of Money, Credit and Banking, Vol. 00, No. 0 (xxxx 2020)

C 2020 The Ohio State University
2 : MONEY, CREDIT AND BANKING
seems to be natural that many mortgage indebted households failed to repay their
mortgages, rather than the unsecured loan. On the other hand, it is also possible that
multiple debtors might prefer to preserve their liquidity for smoothing consumption
by not defaulting on their unsecured credit (Cohen-Cole and Morse 2010, Jagtiani
and Lang 2011, Andersson et al. 2013). Hence, I subsequently examine the impact
of unsecured credit policies—which affect households’ liquidity accessibility—on
the mortgage and unsecured loan defaults.2 Lastly, I analyze the effects of these
unsecured credit policies on reducing mortgage defaults during the financial crisis.
The U.S. government initiated several foreclosure prevention programs after the cri-
sis (Robinson 2009, Gerardi and Li 2010). Instead of examining direct debt relief
programs, this paper normatively analyzes the role of liquidity-related policies in
reducing the foreclosure rate.
When multiple debt holders experience financial difficulties, they might default on
the unsecured loan, instead of the mortgage, to retain homeownership and to relieve
unsecured debt payment burden. In exchange, they cannot access the unsecured loan
market for several years and incur partial pecuniary losses as a default penalty. On
the other hand, households with multiple debts can default only on the mortgage loan
to keep the option of borrowing the unsecured loan in the future. Though mortgage
defaulters do not need to pay the periodic mortgage, they lose their homeownership
and cannot access the mortgage market and buy a new house for several years as a
default penalty. Depending on the benefits and costs of each default option, financially
troubled households can make their optimal default decisions.
To analyze impacts of credit policies on the order of defaults, I introduce a quan-
titative model where households can access two types of loans—the mortgage and
the unsecured loan—if eligible, and default on either loans if necessary. When a
renter has good credit records in both credit markets, it can take out the long-term
mortgage to buy a house and the short-term unsecured loan to share income risk. In
my model, the mortgage is used only for purchasing a new house, and the unsecured
credit is used for sharing income risk and smoothing consumption. A homeowner
that has both the mortgage and the unsecured loan can decide whether to repay the
mortgage as contracted, sell the house, or default on the mortgage. In addition, (s)he
can decide whether to repay the unsecured loan or to default. Once the household
defaults on one of two loans, the household’s credit record in the defaulting sector
becomes bad and it cannot access the defaulted loan market for several years as a
penalty. Hence, households can strategically default on one type of loan to access
the other type, depending on the costs and benefits of each default decision. Both
mortgage and unsecured loan lenders take into account households’ repayment and
default possibilities, and offer loan interest rates in a competitive manner.
After calibrating the steady-state economy to match major household finance-
related moments in the early 2000s, I examine how unsecured credit policies impact
2. Changes in credit underwriting processes or policy guidelines might also significantly impact the
order of defaults. However, I mainly focus on the role of liquidity given the lending standard on households’
default decisions.
JISEOB KIM : 3
households’ optimal default decisions during the financial crisis. To analyze this, I
initially consider a benchmark transition that represents the U.S. economy before
and after the financial crisis. First, given the initial steady-state economy, market
participants face the bankruptcy reform in 2005. The Bankruptcy Abuse Prevention
and Consumer Protection Act (BAPCPA) was enacted in 2005, which made it more
difficult for households to file for Chapter 7 bankruptcy. Starting from 2007, the
average house price suddenly decreases for two consecutive years, mirroring the U.S.
financial crisis. Such an unexpected decrease in the house price increases both the
mortgage foreclosure rate and the bankruptcy rate, as was seen in the United States.
Consistent with the data, my model illustrates that the proportion of households
defaulting only on the mortgage becomes higher than that defaulting only on the
unsecured loan, which was the opposite before the crisis.
Next, I consider a counterfactual transition where households that default on the
unsecured loan can easily reaccess the credit market after the financial crisis. By
comparing the benchmark and the counterfactual transitions, I can examine the effects
of improved unsecured credit accessibility on mitigating households’ defaults after
the crisis. Though an increase in accessibility to the unsecured loan market can
relax budget tightness for financially troubled households, it also leads to an increase
in the value of defaulting on the unsecured loan. In turn, marginal households are
more likely to default on their unsecured loan and give up on repaying their debt.
In addition, financially troubled households with multiple debts are more likely
to default on their debts simultaneously, and then reaccessing the unsecured loan
market immediately. This in turn leads to an increase in the mortgage default rate
as well.
However, when households have more difficulty reaccessing the unsecured loan
market after a default, the cost of defaulting on the unsecured loan increases. This
reduces the unsecured loan default rate. At the same time, multiple debtors are less
likely to default on their loans simultaneously, because of the increased cost of
defaulting on the unsecured loan. This in turn leads to a decrease in the mortgage
default rate.
I also consider experimental economies where the postdefault pecuniary cost de-
creases and the BAPCPA is retracted. My quantitative exercises show that these
relaxed policy stances on unsecured credit cannot reduce both default rates after the
financial crisis.
Related Literature. This paper is closely related to and complements Mitman (2016),
who quantitatively examines effects of bankruptcy and foreclosure policies on house-
holds’ defaults and welfare. However, the main research question and model struc-
tures are quite different. He analyzes state-level default policies and their impact
on households’ default rates. This paper, however, mainly examines whether better
access to liquidity by changing unsecured credit policies can mitigate the prevalence
of mortgage and unsecured loan defaults and alter multiple debtors’ default order
during the financial crisis.3 In terms of model structures, households in both papers
can access two types of credit markets—the mortgage and the unsecured loan—if
eligible and possibly default on their loans if necessary. Households in this paper
cannot access the unsecured credit market if they defaulted on the unsecured loan
and thus have a bad credit record in this credit market. Similarly, households cannot
take out the mortgage if they have a tarnished credit rating in the mortgage market.
However, Mitman (2016) models that households cannot access the unsecured loan
market even if they do not default on the unsecured loan, but default only on the
mortgage.4 Thus, households in my model can strategically default on the mortgage
in order to retain access to the unsecured credit (or liquidity) market, which is not
feasible in Mitman (2016).
Recent empirical research suggests that households make their default decisions
strategically. Especially after the financial crisis, households tend to default more
on their mortgage loans, instead of on unsecured loans such as credit cards or auto
loans (Cohen-Cole and Morse 2010, Komos et al. 2012, Andersson et al. 2013, Chan
et al. 2016). Though there are several possible reasons for the payment priority, these
papers commonly argue that households with negative home equity would like to
access liquidity to share income risk and to smooth consumption by not defaulting on
the unsecured loan. This paper quantitatively examines the underlying mechanism of
households’ strategic defaults and its relation to liquidity accessibility.
This paper also examines the impacts of bankruptcy and unsecured credit policies
on households’ defaults decisions. The U.S. bankruptcy law was reformed in 2005,
which made it harder for households to file for Chapter 7 bankruptcy. According to
Li and White (2009) and Li, White, and Zhu (2011), households tend to default more
on their mortgage debt to relieve their budget after the bankruptcy law is reformed.
Consistent with their prediction, my quantitative exercise shows that the bankruptcy
reform amplifies the mortgage defaults in the short run. Athreya et al. (2015) argue
that the enactment of the BAPCPA substantially reduces the bankruptcy rate during
the crisis but it does not impact the unsecured loan delinquency rate. However, in
my model, the BAPCPA temporarily increases the bankruptcy rate during the crisis
(2008–09), while it reduces the rate afterward. Since their paper does not model the
housing and mortgage markets, households can relieve their financial tightness only
by either filing for bankruptcy or being delinquent. Unlike their paper, I model that
financially troubled households can strategically default on their unsecured loans
or mortgages.
In my model, households can access both the short-term unsecured loan and the
long-term mortgage if they are eligible, and can default on either loans. Hence,
the model structure combines two strands of household debt default literature: the
unsecured loan and the mortgage default models. The former literature includes
3. In the Appendix, I also examine the state-level heterogeneity of default guidelines (recourse schemes
and homestead exemption) and its impacts on the default rate and the homeownership rate.
4. In Kim (2015), eligible households can use two types of loans—the mortgage and the unsecured
loan. However, households are entirely excluded from both credit markets when they default any type
of loans.
JISEOB KIM : 5
Livshits, MacGee, and Tertilt (2007), Chatterjee et al. (2007), Livshits, MacGee, and
Tertilt (2010), Athreya et al. (2015), Athreya et al. (2018), and Sanchez (2018). Papers
dealing with the latter instances include Arslan, Taskin, and Guler (2015), Chatterjee
and Eyigungor (2015), Corbae and Quintin (2015), Guler (2015), Campbell and
Cocco (2015), and Hatchondo, Martinez, and Sánchez (2015).5 Since these papers
consider only one type of loan, it is hard to analyze direct and indirect effects of
changes in default policies for one type of loan on households’ default decisions for
the other type of loan.
This paper is organized as follows. I introduce a quantitative model in Section 1 and
present the benchmark calibration in Section 2. In Section 3, I analyze the benchmark
steady-state economy. Subsequently, I examine effects of changes in unsecured credit
policies on households’ optimal behavior in Section 4. Section 5 concludes the paper.
1. MODEL
Time is discrete and infinite. There are three market participants: households, mort-
gage lenders, and unsecured loan lenders. Each household maximizes the following
expected utility:
∞

E0 β t u(ct , st ), (1)
t=0
where ct is consumption, and st ∈ {H, R} is an indicator function that is H if a

household is a homeowner, and R if a household is a renter. The household’s current
utility is defined by
⎧ ⎫
⎪
⎪ [(1 + κ)c]1−σ ⎪
⎨ if homeowner (s = H )⎪ ⎬
u(c, s) = 1 − σ , (2)
⎪
⎪ c1−σ ⎪
⎪
⎩ if renter (s = R) ⎭
1−σ
where κ is an extra utility gain when a household lives in an owner-occupied house.
This extra utility includes pecuniary and nonpecuniary benefits for staying in an
owner-occupied house, which are not explicitly modeled in this paper.6 Every house-
hold can own at most one house.
Idiosyncratic shocks: There are two types of idiosyncratic shocks: income
(e) and house price ( p) shocks. Both shocks follow an AR(1) process. Let ē be the
median income, and p̄ be the median house price. Then, the log income process
evolves as follows:
log(et ) = (1 − ρe )log(ē) + ρe log(et−1 ) + εt , (3)
5. Davis and Van Nieuwerburgh (2015) summarize details about housing finance-related papers.
6. For example, Gervais (2002) and Chambers, Garriga, and Schlagenhauf (2009) examined the
preferential tax provision of housing equity when households own owner-occupied houses.
where εt ∼ i.i.d.N(0, σe2 ). Similarly, the log house price has the following process:
log( pt ) = (1 − ρ p )log( p̄) + ρ p log( pt−1 ) + νt , (4)
where νt ∼ i.i.d.N(0, σp2 ). In computation, I discretized both shock processes follow-

ing Tauchen (1986).
If a household cannot afford to buy a house, it can stay in a rental house by paying
a periodic rent z. Every renter also faces idiosyncratic rent price shocks. I model that
the house price is determined by the discounted value of future periodic rents. Hence,
the periodic rent is given by
rf
z t = pt , (5)
1+rf
where r f is the risk-free rate.7

Households’ credit records: Households can access two types of loans—the
mortgage and the unsecured loan—if they are eligible. When a household purchases
a new house, it can take out the long-term mortgage loan. Both homeowners and
renters can also take out a one-period unsecured loan if they have a good credit
record in the unsecured loan market. Indebted households can default on their loans
if necessary. Once a household defaults on the unsecured loan, it gains a bad credit
record in the unsecured credit market. However, the household can still access the
mortgage market because its mortgage credit record is not tarnished. The bad credit
record in the unsecured credit market recovers a good rating with a probability
of αU .
When a household defaults on the mortgage loan, it loses its house and gains
a bad credit record in the mortgage market. However, the defaulter can still ac-
cess the unsecured credit market if (s)he keeps repaying the unsecured loan.8 The
bad credit record in the mortgage credit market will recover with a probability
of α M .
A financially troubled household can also default on both types of loans, leading
to bad credit ratings in both credit markets. At the same time, it cannot access both
credit markets for several periods as a default penalty.
7. I assume that every renter pays periodic rents. Hence, the house price is calculated by discounting
rent prices with the risk-free rate.
8. In the real world, households that default on their mortgages face a decrease in their credit score,
which limits accessibility of the unsecured loan. To make both credit markets interconnected, one can
introduce a credit score, as was done in Chatterjee et al. (2016), which measures credit worthiness and
accessibility. However, it is challenging to include a credit score with two types of loans in a computationally
tractable manner. This would be an interesting avenue for future research. Though this model assumption
does not fully reflect the real credit market, the main objective of this paper is to analyze the priority of
loan payments in a simple and tractable way.
JISEOB KIM : 7
In sum, each household’s credit status can be categorized into four types.9
Mortgage loan
credit record
G B
G (G, G) (G, B)
Unsecured loan
B (B, G) (B, B)
credit record
If a household has good credit ratings in both the mortgage and the unsecured loan
markets, its credit record is given by (G, G). When a household defaults only on the
unsecured loan, the unsecured credit record is tarnished and its credit status becomes
(B, G). Similarly, a mortgage defaulter’s credit status becomes (G, B). If a household
defaults on both types of loans, its credit record is (B, B).
Loan structures: In this model, there are two types of loans: the long-term
mortgage loan and the short-term unsecured loan. When a renter buys a house at time
t, she can take out a fixed-rate mortgage loan if her credit record in the mortgage
sector is good.10 The household takes out m units of mortgage bonds with a price
q M . Then, the total outstanding loan balance is given by q M m. Once the household
borrows the mortgage loan at time t, the household repays m at time t + 1, δm at
time t + 2, δ 2 m at time t + 3, and so on, where δ ∈ [0, 1]. That is, the household’s
repayment decreases with the rate of δ. The parameter δ represents the amortization
scheme of the mortgage contract.11 It is also possible to interpret it as the mortgage
contract length. In other words, the mortgage contract terminates at time t + 1 with
a probability of 1 − δ, at time t + 2 with a probability of δ(1 − δ), at time t + 3 with
a probability of δ 2 (1 − δ), and so on. Then, the expected mortgage contract length is
given by 1/(1 − δ).12
The unsecured credit is a one-period loan. Any household with good credit in the
unsecured loan market is eligible for this loan. However, households with bad credit
cannot take out the unsecured loan, but can instead save financial assets. Let a be the
saving if it is positive and the borrowing if it is negative, and let qU be the unit price
9. In the real world, a credit score – such as a FICO score – represents a household’s creditworthiness.
Since I examine strategic default patterns between the mortgage and the unsecured loan, I simply model
that different sectors’ credit rates are independently determined. Though this is a strong assumption, I
construct a model in a tractable manner. In addition, as will be presented later, each loan defaulter faces
different pecuniary penalties and outside options.
10. For simplicity, I do not consider the home equity line of credit, the seller financing, or the
refinancing. Only home purchasers can take out mortgage loans secured by their new homes. If a household
wants to take out loans for consumption, it can use unsecured credit. According to my tabulations with
the Survey of Consumer Finances data, the proportion of the fixed-rate mortgage is 89% in 2001, 86%
in 2007, and 93% in 2016. Hence, I mainly focus on the fixed-rate mortgage, rather than the adjustable-
rate mortgage.
11. This mortgage payment stream is also used in Chatterjee and Eyigungor (2015).
12. The expected mortgage contract length is calculated by Pr(contract terminates at time t+1) × 1
∞
+ Pr(contract terminates at time t + 2) × 2 + · · · = t=1 (1 − δ)δ t−1 t = 1/(1 − δ). This method is also
used in Kim and Wang (2018).
of the unsecured loan.13 Then, the total unsecured loan is given by qU a if a < 0. In
the next period, the indebted household repays a to the unsecured loan lender if it
does not default. If a ≥ 0, qU a is the saving. And, the financial intermediary pays a
to the household in the next period.
Bankruptcy policy: Financially troubled households that have an unsecured
loan can default on it. Those households can file for bankruptcy and (partly) relieve
their unsecured debt burden. However, when a mortgage debtor with an unsecured
loan files for bankruptcy, its mortgage debt will not be discharged. Since the Chapter
7 bankruptcy comprises a significant portion of nonbusiness bankruptcy filings in the
United States, I focus only on this type.14
When a homeowner files for bankruptcy, (s)he has to partly compensate losses
incurred by unsecured loan lenders. If the home equity (= house value − mortgage
balance) net of homestead exemption (the fraction ϕ of the house value) is negative,
the homeowner does not need to pay anything to the lender. However, if it is positive,
the household must pay either the original unsecured debt or the home equity net
of homestead exemption, whichever is smaller. Unlike a homeowner, when a renter
defaults on her unsecured loan, her debt will be fully discharged under Chapter 7.15
I model that not every household can default on its unsecured debt. To file for
bankruptcy, the indebted household’s income must be lower than a certain threshold
ê. Before 2005, filing for Chapter 7 bankruptcy was relatively easy. In 2005, the
U.S. government enacted the BAPCPA, which made it more difficult for indebted
households to file for Chapter 7 bankruptcy. According to the BAPCPA, debtors
whose monthly income is higher than the residential state’s median income cannot
file for bankruptcy. This is often referred to as the so-called means test. In addition,
debtors who want to file for bankruptcy must take credit counseling classes and
complete an instructional course on personal financial management. Otherwise, they
are not eligible for bankruptcy. Though the BAPCPA includes several provisions, I
simplified the model structure by incorporating only the means test.
Foreclosure policy: A financially troubled mortgage debtor has the option
to default on its mortgage loan in exchange for losing homeownership. Then, the
mortgage lender takes the ownership of the house, sells it, and (partly) recovers the
loss incurred from the mortgage default. However, the financial intermediary cannot
receive the full value of the foreclosed house. It incurs a deadweight loss (or the
foreclosure cost), which is the fraction χ D of the house value. That is, the financial
13. The saving–borrowing a can also be interpreted as the net financial asset.
14. According to the American Bankruptcy Institution, Chapter 7 bankruptcy filings account for
around 70% of the total nonbusiness bankruptcy filings. Though Mitman (2016) takes into account both
Chapter 7 and 13 bankruptcies, I tried to simplify the model structure and focus on the payment/default
hierarchy between mortgage and unsecured loans.
15. Since the unsecured credit lender can claim part of home equity in case of the default, it might
be possible to interpret the unsecured loan as the second (or subordinate) mortgage loan. However, the
lender’s power of recovering home equity mainly depends on each state’s bankruptcy guidelines. In other
words, it is the unsecured loan without having the homestead exemption clause. In addition, when renters
default on the unsecured loan, the lender cannot claiming anything from defaulters. In that sense, it is
natural to interpret the loan as the unsecured credit, rather than the second mortgage.
JISEOB KIM : 9
intermediary can recover the fraction 1 − χ D of the house value in exchange for
giving up periodic payments.
If the defaulted mortgage balance is higher than the house value net of the foreclo-
sure cost, the mortgage lender can (partly) collect a household’s financial assets and
reduce their final losses. That is, the financial intermediary can recover the fraction ξ
of its final loss (the mortgage balance—the house value net of the foreclosure cost).
This partial recovery reflects the recourse scheme in the U.S. mortgage market. The
recourse mortgage lender can recover losses by collecting both the house and the
financial assets held by the defaulting household.16 However, when a mortgage is
nonrecourse, the lender can recover its losses by collecting only the house owned by
the defaulting household. In addition, each state in the United States has different
mortgage foreclosure timelines and legal processes (Zhu and Pace 2015). Even among
states that have adopted the recourse mortgage scheme, same lenders are required
to seek judicial permission to foreclose the defaulted house, leading to delays in the
foreclosure process. This delay can possibly increase the financial intermediary’s
final losses (Gerardi, Lambie-Hanson, and Willen 2013). The parameter ξ captures
these additional costs.
Households’ behavior: A renter with good credit in the mortgage market can
buy a house by taking out a mortgage. If the purchaser has good credit in the unsecured
loan market, she can also take out the unsecured loan. When the household buys a
house, it has to pay the transaction cost, which is the fraction χ B of the house value.
In the next period, depending the realization of income and house price shocks, the
household decides whether to repay the mortgage as contracted, to sell the house, or
to default on the mortgage. At the same time, if the household has an unsecured loan,
it decides whether to repay or to default. When the household defaults on either type
of loan, its credit record in the corresponding sector suffers.
If the household decides to sell the house, the household must repay the discounted
value of the future mortgage payment stream, receive the house value net of the
transaction cost (the fraction χ S of the house value), and become a renter. That is,
when the household has to repay {m, δm, δ 2 m, . . .} in the future, the house seller must
pay ∞ t=0 δ m/(1 + r f ) . Since the household does not default on its mortgage, it
t t 17
still has a good credit record in the mortgage market.

When a household defaults on its mortgage, it does not need to pay the mortgage
loan but loses its homeownership. In addition, the defaulting household pays the
16. Feldstein (2008) argued that mortgages originated in the United States are effectively nonrecourse.
However, the mortgage payment and default patterns of recourse and nonrecourse mortgages are quite
different, as reported in Ghent and Kudlyak (2011). Hence, I analyze how the introduction of recourse
mortgages impacts optimal households’ behavior. Kim (2015), Mitman (2016), and Gete and Zecchetto
(2018) also analyze the impact of recourse and nonrecourse schemes on optimal default behavior.
17. In the real world, the current loan balance can be calculated by discounting future payments
with the mortgage interest rate, rather than the risk-free rate. If I discount the future cash flow with
the (endogenously determined) mortgage interest rate, I need an additional state variable, leading to a
significant increase in computational burden. Also, the mortgage interest rate is usually higher than the risk-
free rate, reflecting the default risk premium. Thus, by discounting with the risk-free rate, the loan balance
might be overestimated. However, since I do not consider the prepayment penalty, the overestimated
balance might not be unnatural. Chatterjee and Eyigungor (2015) also use this methodology.
fraction ξ of the bank’s final loss (= the mortgage balance − the house value net of
the foreclosure cost), and loses the fraction φ M of income as a default penalty. Since
the household defaults on its mortgage, its credit record in the mortgage market turns
bad. However, this bad credit record in the mortgage market returns to a good record
again with a probability of α M .
For each mortgage payment decision, the household also decides whether to repay
or default on the unsecured loan. If the household defaults, its unsecured credit record
turns bad. In addition, the defaulting homeowner needs to pay the home equity net
of the homestead exemption if it is positive and less than the indebted balance, and
loses the fraction φU of income as a default penalty.18 The household’s bad credit
record in the unsecured loan market is restored with a probability of αU .
In sum, a household that has both the mortgage and the unsecured loan has six
options to choose in the next period: (repay the mortgage, repay the unsecured
loan), (repay the mortgage, default on the unsecured loan), (sell the house, repay
the unsecured loan), (sell the house, default on the unsecured loan), (default on
the mortgage, repay the unsecured loan), (default on the mortgage, default on the
unsecured loan). If the household has a good credit record in the mortgage (unsecured
loan) market, it can access the mortgage (unsecured loan) credit, regardless of the
credit status in the unsecured (mortgage) loan market. Hence, the homeowner can
strategically default on its mortgage debt to access the unsecured credit market for the
purpose of sharing income risk and smoothing consumption, in exchange for losing
homeownership. On the other hand, the household can default on its unsecured loan
to keep the house, in exchange for giving up the future unsecured borrowing option.
Renters with a bad credit record in the mortgage market cannot access the mortgage
credit and are not eligible to buy a house. To buy a house, they must wait until their
credit improves. In addition, I model that only renters with positive (net) financial
assets are eligible to buy a house.
Financial intermediaries’ behavior: Financial intermediaries offer mortgage
and unsecured loan prices (or interest rates) competitively. In this model, I assume
that there is no information asymmetry between borrowers and lenders, or between
mortgage lenders and unsecured loan lenders. As will become clear later, financial
intermediaries take into account the possibility of household defaults and propose
mortgage and unsecured loan prices independently. If the financial intermediary
expects to face significant losses, it will charge high loan interest rates. However, if
the financial intermediary expects to fully recover the loans as originally contracted,
the interest will be at the risk-free rate.
1.1 Households’ Optimal Problems

There are two types of households: homeowners and renters. In addition, I can
categorize each household based on credit records—(G, G), (G, B), (B, G), and
18. A defaulting household might face both pecuniary and nonpecuniary costs, such as filing and
lawyers’ fees, and stigma cost (Fay, Hurst, and White 2002, Livshits, MacGee, and Tertilt 2010). The
parameters φ M and φU capture such unmodeled costs.
JISEOB KIM : 11
(B, B)—and repayment, selling, and default choices. In this subsection, I introduce
how each household makes its optimal decisions. In total, I can define 14 households’
value functions. I introduce three major value functions in this subsection, and the
remaining 11 value functions are presented in Appendix A.1.
Home purchaser with (G, G) credit records: When a renter who has good
credit records in both the mortgage and unsecured loan markets decides to buy a
house, (s)he solves the following problem:
P (G,G) (a, e, p) = max u(c, H ) + β E e , p |e, p

c≥0,a ∈R,
m≥0
⎡ ⎧ (G,G) ⎫ ⎤
⎪
⎪ H (a , e , p , m),⎪ ⎪
⎢ ⎪
⎪ ⎪
⎪ ⎥
⎢ ⎪
⎪ (B,G)
, ,
, ⎪
⎪ ⎥
⎢ ⎪ D
⎪ H (a e p m), ⎪
⎪ ⎥
⎢ ⎪
⎪ ⎪
⎪ ⎥
⎢ ⎨S (G,G)
(a , e , p , m), ⎬

⎥
⎢ I {e < ê} max ⎥
⎢ I1 (a ,e , p ,m)⎪⎪ S (B,G)
(a , e , p
, m), ⎪
⎪ ⎥
⎢ ⎪
⎪ D ⎪
⎪ ⎥
⎢ ⎪
⎪ ⎪
⎪ ⎥
×⎢ ⎪
⎪ R D (a , e , p , m), ⎪
(G,B)
⎪ ⎥
⎢ ⎪
⎪ ⎪
⎪ ⎥
⎢ ⎩ (B,B) ⎭ ⎥
⎢ R (a = 0, e , p ) ⎥
⎢ ⎧ (G,G) ⎫⎥
⎢ ⎪ H (a , e , p , m),⎪⎥
⎢ ⎨ ⎬⎥
⎢ S (G,G) (a , e , p , m), ⎥
⎣+ I {e ≥ ê} max ⎦
I2 (a ,e , p ,m)⎪
⎩ (G,B) ⎪
⎭
R D (a , e , p , m)
s.t.

c + qUH a , e, p, m a + (1 + χ B ) p = e + a + q M
G
a , e, p, m m. (6)
Since the household has good credit ratings in both markets, it has the option to take
G
out the mortgage and the unsecured loan. Let q M (·) be the price of the mortgage
H
loan and let qU (·) be the unsecured loan price, which will be defined in the financial
intermediaries’ problems. Once the household takes out the mortgage and decides
to repay it as contracted, the payment in the next period is m. When the household
takes out the unsecured loan (a < 0), it repays |a | if it does not default. The house
purchaser pays the transaction cost, which is the fraction χ B of the house price. In
the next period, depending on the realization of income and house price shocks, the
household chooses one of following options: repay the mortgage and the unsecured
loan (H (G,G) ), repay the mortgage loan and default on the unsecured loan (H D(B,G) ),
sell the house and repay the unsecured loan (S (G,G) ), sell the house and default on
the unsecured loan (S D(B,G) ), default on the mortgage loan and repay the unsecured
loan (R (G,B)
D ), and default on both types of loans (R (B,B) ). The superscript of value
functions denotes households’ credit records. If the household’s income in the next
period is lower than the threshold for the means test (ê), the indebted household has
an option to default on the unsecured loan. However, the household is not eligible to
default on the unsecured loan if income is higher than the threshold.
Homeowner that defaults only on the unsecured loan: A homeowner that
defaults on the unsecured loan and repays the mortgage solves the following problem:
H D(B,G) (a, e, p, m) = max u(c, H ) + β E e , p |e, p

c≥0,a ≥0
⎡ ⎧ (G,G) ⎫ ⎤
⎪ H (a , e , p , δm),⎪
⎢ ⎨ ⎬ ⎥
⎢αU max S (G,G) (a , e , p , δm), ⎥
⎢ ⎪
⎩ (G,B) ⎪
⎭ ⎥
⎢ ⎥
⎢ R D (a , e , p , δm)
×⎢ ⎧ (B,G) ⎫⎥⎥
⎢ ⎪ H (a , e , p , δm),⎪⎥
⎢ ⎨ ⎬⎥
⎢+ (1 − α ) max S (B,G) (a , e , p , δm), ⎥
⎣ U
⎪ ⎪⎦
⎩ ⎭
R (B,B)
D (a , e , p , δm)
s.t.
a
c+ + m + I { p − A(m)
1+rf
− ϕp ≥ 0} min { p − A(m) − ϕp, |a|} = (1 − φU )e. (7)
Since the household has bad credit history in the unsecured loan market, it cannot
borrow the unsecured loan. However, the household can save a with the risk-free
rate. Let A(m) be the current loan balance defined by ∞ t=0 δ m/(1 + r f ) . If the
t t
household’s home equity (= p − A(m)) net of homestead exemption (ϕp) is larger

than zero, the unsecured loan lender can partially recover the loss from the defaulting
household. If the home equity net of exemption is less than the unsecured loan
balance, the defaulting household must pay the former from its income. However, if
the former is larger than the latter, the defaulting household must fully pay back the
unsecured debt. Hence, households that hold significant housing assets cannot enjoy
the benefit of the debt discharge from filing for bankruptcy. Since the household
defaults only on the unsecured loan, it still has to pay the current mortgage burden
m. The mortgage burden in the next period decreases to δm. A household with bad
credit incurs income losses in the amount of φU e. In the next period, the household’s
bad credit record in the unsecured loan market will be restored with a probability of
αU . Since the household cannot take out the unsecured loan currently, it will have
no unsecured loan to default in the next period. The household will choose whether
to repay the mortgage as contracted (H (G,G) if the bad unsecured credit record is
recovered, H (B,G) if otherwise), sell the house (S (G,G) if the bad unsecured credit
record is recovered, S (B,G) if otherwise), or default on the mortgage loan (R (G,B)
D if
the bad unsecured credit record is recovered, R (B,B)
D if otherwise).
Homeowner that defaults only on the mortgage loan: When a homeowner
defaults on the mortgage and repays the unsecured loan, (s)he solves the following
JISEOB KIM : 13
optimization problem:
R (G,B)
D (a, e, p, m) = max

u(c, R)
c≥0,a ∈R
⎡ ⎧ ⎧ ⎫ ⎫ ⎤
⎪
⎪ ⎨ R (G,G) (a , e , p ),⎬ ⎪
⎪
⎢ ⎪ ⎪
I {a ≥ 0} max ⎪
⎪ ⎥
⎢ ⎪ ⎪
⎪ ⎩ P (G,G) (a , e , p ) ⎭ ⎪
⎪
⎪ ⎥
⎢ ⎪ ⎪ ⎥
⎢ ⎨ ⎧ ⎧ ⎫ ⎫ ⎬ ⎥
⎢α M ⎪ ⎨ (G,G)
(a , e , p ), ⎬ ⎪ ⎥
⎢ ⎪ ⎪
⎨ I {e < ê} max
R ⎪
⎬⎪ ⎥
⎢ ⎪ ⎪ ⎥
⎢ ⎪ ⎪+ I {a < 0}
⎪ ,e , ⎩ ⎭ ⎪
⎪
⎪ ⎥
⎢ ⎪ ⎪ ⎪
I 4 (a p )
R (B,G)
(a = 0, e , p ) ⎪⎪ ⎪ ⎥
⎢ ⎪ ⎩ ⎪
⎩ ⎪
⎭⎭ ⎪ ⎥
+β E e , p |e, p ⎢
⎢ + I {e ≥ ê}R (G,G) (a , e , p ) ⎥
⎥
⎢ ⎧
⎫ ⎥
⎢ ⎪
⎪ I {a ≥ 0}R (G,B)
(a , e , p ) ⎪
⎪ ⎥
⎢ ⎪
⎪ ⎧ ⎫⎫⎪⎪ ⎥
⎢ ⎪ ⎧ ⎪ ⎥
⎢ ⎨ ⎪ ⎨R (G,B)
,
, ⎬⎪ ⎬ ⎥
⎢+ (1 − α ) ⎪
⎨
(a e p ), ⎪
⎬ ⎥
⎢ M
⎪+ I {a < 0} I {e < ê} max ⎥
⎢ ⎪ I5 (a ,e , p )⎩ (B,B) ⎭ ⎪ ⎪ ⎥
⎣ ⎪
⎪ ⎪ R (a = 0, e , p ) ⎪ ⎪
⎪ ⎦
⎪
⎩ ⎪
⎩ ⎪
⎭⎭⎪
(G,B)
+ I {e ≥ ê}R (a , e , p )
s.t.
c + qUR B (a , e, p)a + z( p) + ξ max {0, A(m) − (1 − χ D ) p} = (1 − φ M )e + a. (8)
Since the household defaults on the mortgage loan, it loses its home, partly com-
pensates the mortgage lender’s losses, and pays the periodic rent z( p). From the
foreclosure procedure, the lender can recover the fraction 1 − χ D of the house value.
If the mortgage balance is higher than the house value net of the foreclosure cost, the
mortgage lender loses A(m) − (1 − χ D ) p. Then, the mortgage defaulter compensates
the fraction ξ of the lender’s (positive) loss. In addition, the defaulting household
loses a fraction φ M of income. Since the household still has a good credit record in
the unsecured loan market, it can access the unsecured loan with the price of qUR B (·).
In the next period, the household’s bad credit record in the mortgage market will be
recovered with a probability of α M . The household has an option to buy a house if
it has positive net financial assets and a good credit rating in the mortgage market.
However, the household can also voluntarily stay in the rental house (R (G,G) ) with
accumulating financial assets. The household can default on the unsecured loan in the
next period only if its income is less than ê. If the household defaults while staying
in a rental house, its credit rating in the unsecured loan market turns bad (R (B,G) ). By
a probability of 1 − α M , the household still has a bad credit rating in the mortgage
market, and is not eligible to buy an owner-occupied house, and thus must stay in a
rental house (R (G,B) ). If the (G, B)-credit household defaults on the unsecured loan,
its credit record becomes (B, B).
1.2 Unsecured Loan Lenders’ Problem

The unsecured credit market is competitive and unsecured loan lenders are risk
neutral. I model that the risk-free interest rate is exogenously given. The unsecured
loan lender finances funds from outside of the economy with the risk-free rate, and
lends money to unsecured loan consumers. However, households cannot directly
access such funds with the risk-free rate. Instead, they are only able to borrow money
through unsecured loan lenders. In addition, I assume that these lenders never default
and always commit the loan and saving contract.
Let me explain how to determine the unsecured loan price qUH , which is offered to
homeowners with a credit rating (G, G).19 For notational simplicity, let 1 be the set
of state variables (a , e, p, m), and let 1 be the state variables after the realization
of income and house prices in the next period (a , e , p , m). The household decides
whether to default on the unsecured loan depending on the realization of income and
house price shocks. Let DUH (·) be an indicator function that is 1 if the household
does not default on the unsecured loan after realizing idiosyncratic shocks, and 2 if
it defaults only on the unsecured loan.
⎧ ⎫
⎨1 if I1 1 = H (G,G) , S (G,G) , R (G,B)
D , or e ≥ ê⎬
DUH 1 = . (9)
⎩2 if I1 1 = H D(B,G) , S D(B,G) and e < ê ⎭
When the unsecured loan lender makes the credit contract with a (G, G)-credit
homeowner, its expected profit UH (·) is defined by
UH (1 ) (10)

⎧ H ⎫
⎪
⎪qU (1 )a − a
if a ≥ 0⎪
⎪
⎪
⎪
1+r f
⎪
⎪
⎪
⎪ H ⎪
⎪
⎪
⎨qU (1 )a ⎪
⎬
= ⎡ H ⎤ .
⎪ I DU 1 = 1 a
⎪
⎪ ⎢ ⎥ if a < 0⎪
⎪
⎪
⎪ ⎪
⎪− 1+r f E e , p |e, p ⎣−I DUH 1 =
⎪ ⎪
1
⎪ 2 I p − A(m) − ϕp ≥ 0 ⎦ ⎪
⎪
⎩ ⎭
× min p − A(m) − ϕp , a
When the household saves (a ≥ 0), defaults do not happen. Hence, the unsecured
loan lender receives funds qUH (1 )a from the household, and pays back a in the next
period. Since the financial market is competitive, the unsecured loan lender’s profit
must be equal to zero, and thus the price of the savings is 1/(1 + r f ).
When the household takes out the loan by the amount of qUH (1 )a , where a < 0,
the lender must consider the expected future cash inflow. If the household repays the
loan in the next period (or DUH (1 ) = 1), the lender will receive |a |. However, if
the household defaults only on its unsecured loan (or DUH (1 ) = 2), the lender can
partly recover its losses. If the household’s home equity net of homestead exemption
is positive, the lender can recover the minimum value of the home equity net of
exemption ( p − A(m) − ϕp ) and the original unsecured debt (|a |). I model that the
unsecured loan lender cannot recover the home equity if the household defaults on
19. The unsecured loan prices offered to renters are presented in Appendix A.2.
JISEOB KIM : 15
both the mortgage and the unsecured loan (R (B,B) ).20 For each household state 1 ,
the loan price qUH (1 ) is pinned down by satisfying the zero profit condition.
1.3 Mortgage Lenders’ Problem

The mortgage credit market is also competitive and mortgage lenders are risk
neutral. Similar to the unsecured loan market, mortgage lenders can finance funds
with the risk-free rate, and originate mortgage loans to home purchasers. However,
home buyers cannot directly access such funds. They can borrow funds only from
mortgage lenders.
When a home buyer with good credit history in both loan markets takes out the
mortgage, it decides whether to repay, sell the house, or default on the mortgage
depending on the realization of income and house price shocks. In addition, the
household can possibly default on the unsecured loan, influencing the mortgage
G
lender’s expected cash inflow. Let D M be an indicator function that defines (G, G)-
credit home buyer’s discrete choices after realizing idiosyncratic shocks.21
⎧ ⎫
⎪
⎪ 1 if I1 1 = H (G,G) and e < ê, or I2 1 = H (G,G) and e ≥ ê ⎪
⎪
⎪
⎪ ⎪
⎪
⎪
⎪ 2 if I1 1 = HD (B,G)
and e < ê ⎪
⎪
⎨ (G,G) (B,G) ⎬
G
DM 1 = 3 if I1 1 = S , SD and e < ê, or I2 1 = S (G,G) and e ≥ ê . (11)
⎪
⎪ ⎪
⎪
⎪
⎪ 4 if I1 1 = R (G,B) and e < ê, or I2 1 = R (G,B) and e ≥ ê ⎪
⎪
⎪
⎪ D D ⎪
⎪
⎩ ⎭
5 if I1 1 = R (B,B) and e < ê
G
The function D M (·) is 1 if the household does not default on any loans, 2 if the
household defaults only on the unsecured loan, 3 if the household sells the house,
4 if the household defaults only on the mortgage, and 5 if the household defaults
on both types of loans. The mortgage lender’s cash inflow is different depending on
households’ decisions. Then, the mortgage lender’s expected profit function GM (·)
is defined by
GM (1 ) (12)

= −q M
G
(1 )m
⎡ G ⎤
I D M 1 = 1 m + q M G
a H (G,G) , e , p , δm δm
⎢ ⎥
⎢+I D G = 2 m + q B a , e , p , δm δm ⎥
⎢ M 1 M H D(B,G) ⎥
1 ⎢ ⎥
+ E e , p |e, p ⎢
⎢ +I D G

= 3 A(m) ⎥.
⎥
1+rf ⎢
M 1
⎥
⎢+I D G = 4(1 − χ D ) p + ξ max 0, A(m) − (1 − χ D ) p ⎥
⎣ M 1 ⎦
G
+I D M 1 = 5 (1 − χ D ) p
20. When the household defaults on both types of loans, the mortgage lender will claim the home
equity that is the security for the mortgage. Hence, for simplicity, I assume that the unsecured loan lender
cannot claim the home equity from households defaulting on both loans.
21. The mortgage price faced by (B, G)-credit home buyer is presented in Appendix A.3.
G
When the (G, G)-credit household takes out a mortgage in the amount of q M (1 )m,
the mortgage lender can expect to recover either the full or partial amount of debt. Af-
ter the realization of income and house price shocks, if the household decides to repay
both loans (D M G
(1 ) = 1), the lender can recover the periodic payment m. In addition,
G
the lender can expect to receive the future payment stream q M (a H (G,G) , e , p , δm)δm,

where a H (G,G) (= a H (G,G) (1 )) is the saving policy function faced by the (G, G)-credit
homeowner under the state 1 . When the household defaults on the unsecured loan
and repays the mortgage (D M G
(1 ) = 2), the lender can recover the periodic payment
m and the expected future cash inflow q MB (a H (B,G) ,e , p ,δm)δm . Since the household’s credit
D
status becomes (B, G) when it defaults on the unsecured loan only, it has different
options to choose in the next period, which influences the lender’s expected cash
inflow. The expected cash flow stream q MB (·)δm , which is described in Appendix A.3,
reflects such changes in the household’s available discrete options. The net financial
asset a H (B,G) is the saving policy of the (B, G)-credit homeowner defaulting only on
D
the unsecured loan (a H (B,G) (1 )). When the household sells the house ( D MG (1 )=3), the
D
mortgage lender can recover the loan balance A(m). If the household defaults only
on the mortgage, the lender can recover the house value net of the foreclosure cost. In
addition, the lender can partly recover the final loss through exercising the recourse
option: ξ max{0, A(m) − (1 − χ D ) p }. When the household defaults on both types of
loans, I model that the mortgage lender can recover only the collateral value (house
value) net of the foreclosure cost.22 For each state (1 ), mortgage loan prices are
determined by satisfying the zero profit condition.
1.4 Definition of a Steady-State Equilibrium
A steady-state equilibrium consists of value functions, household policy functions,
unsecured loan and mortgage price schedules, and an invariant distribution such
that:
1. Household policy functions are optimal given unsecured loan and mortgage
price schedules.
2. Given household policy functions, unsecured loan price schedules are deter-
mined by the unsecured loan lenders’ zero profit condition.
3. Given household policy functions, mortgage price schedules are determined
by the mortgage lenders’ zero profit condition.
4. The cross-sectional distribution is invariant given optimal household policy
functions, unsecured loan prices, and mortgage prices.
2. CALIBRATION
I choose model parameters based on the U.S. economy in the early 2000s. Given
the benchmark steady state, I examine how the enactment of the BAPCPA in 2005, an
22. For simplicity, I model that the mortgage lender cannot claim financial assets held by the household
defaulting on both loans.
JISEOB KIM : 17
unexpected drop in house prices from 2007 to 2009 mirroring the U.S. financial crisis,
and changes in unsecured credit policies impact households’ behavior. A period in
the model is a year. The annual risk-free rate r f is 3%, reflecting the average 1-year
T-bill rate in 2000. The risk aversion parameter σ is set to 2, which is standard in
the literature.
The median income ē is normalized to 1. Income process parameters (ρe , σe2 ) are
given as (0.99, 0.017), which come from Storesletten, Telmer, and Yaron (2004).
House price process parameters (ρ p , σ p2 ) are taken from Hatchondo, Martinez, and
Sánchez (2015).
The mortgage payment parameter δ reflects the amortization scheme. At the same
time, it is also possible to interpret the parameter as the mortgage contract length.
According to the 2001 and 2004 Survey of Consumer Finances (SCF), the 30-year
residential mortgage is the most prevalent type of the contract. I choose the parameter
δ to match the 30-year contract.
When a household buys and sells a house, it has to pay the transaction cost, which
is a fraction χ B and χ S of the house price, respectively. I choose the parameter χ B
as 2.5% and χ S as 7%, following Gruber and Martin (2003). When the household
defaults on its mortgage and the house is foreclosed, the financial intermediary
recovers the house value net of the foreclosure cost. Following Pennington-Cross
(2006), the foreclosure cost χ D is 22% of the house price.
When a household defaults on the unsecured loan, the household cannot access
the unsecured credit market for several periods. However, the bad credit flag will be
eliminated with a probability of αU . I set the parameter αU as 0.167, reflecting the fact
that unsecured loan defaulters cannot reaccess the unsecured loan market for 6 years
on average (Mitman 2016). The foreclosed household cannot reaccess the mortgage
market for 4 years on average, following Chatterjee and Eyigungor (2015). In addition
to limited access to credit markets, unsecured loan and mortgage defaulters also face
income losses φU e and φ M e, respectively. To reduce free parameters, I normalized
the parameter φ M as zero.
Each state in the United States has different foreclosure processes and recourse
schemes. Since the model represents the entire U.S. economy, and not a certain state,
I need to choose a recourse parameter ξ that represents the economy on a national
level. Ghent and Kudlyak (2011) categorize each state as recourse or nonrecourse,
and as judicial or nonjudicial foreclosure. It is known that states with the judicial
foreclosure process have longer foreclosure timelines (Cutts and Merrill 2008). In
addition, borrowers residing in judicial foreclosure states are more likely to be seri-
ously delinquent in their mortgages, which makes lenders less likely to recover their
losses (Gerardi, Lambie-Hanson, and Willen 2013). Hence, when mortgage lenders
issue loans to households residing in either nonrecourse or judicial foreclosure states,
their chance to recover final losses will decrease (or ξ = 0). However, their chance
of recovery will be high if they issue contracts to borrowers residing in recourse and
nonjudicial foreclosure states (or ξ = 1). According to the categorization described
in Ghent and Kudlyak (2011), there are 21 states in the United States where mort-
gages are recourse and the foreclosure process is nonjudicial.23 Since lenders in these
TABLE 1
CALIBRATION
Parameter Description Value Target/source
Non-target parameters
rf Risk-free rate 0.03 1-year Treasury rate
σ Risk aversion 2 Hatchondo, Martinez, and Sánchez (2015)
ē Median income 1 Normalized to one
ρe Persistence in income process 0.99 Storesletten, Telmer, and Yaron (2004)
σe 2
Variance of income process 0.017 Storesletten, Telmer, and Yaron (2004)
ρp Persistence in house price process 0.97 Hatchondo, Martinez, and Sánchez (2015)
σ p2 Variance of house price process 0.302 Hatchondo, Martinez, and Sánchez (2015)
δ Mortgage contract length 0.967 30-year contract
χB Transaction cost—Buying 0.025 Gruber and Martin (2003)
χS Transaction cost—Selling 0.07 Gruber and Martin (2003)
χD Foreclosure cost 0.22 Pennington-Cross (2006)
αU Market exclusion after bankruptcy 0.167 Mitman (2016)
αM Market exclusion after foreclosure 0.25 Chatterjee and Eyigungor (2015)
φM Default penalty after foreclosure 0 Normalized to zero
ξ Recourse rule 0.32 Ghent and Kudlyak (2011)
ϕ Homestead exemption 0.24 Morgan, Iverson, and Botsch (2009)
ê Bankruptcy means test criteria ∞ Pre-BAPCPA
Target parameters
β Discount factor 0.831 Bankruptcy and foreclosure rate
φU Default penalty after bankruptcy 0.34 Bankruptcy and foreclosure rate
κ Homeowner’s extra utility 0.251 Homeownership rate
p̄ Median house price 3.88 House-value-to-income ratio
states can quickly terminate the foreclosure process and recover their losses, I set the
parameter ξ for these states as 1. I allocate that other states have the parameter ξ of
0. The ratio of the population residing in recourse and nonjudicial states to the total
population in the United States is around 0.32. Hence, I set the benchmark parameter
ξ as 0.32.
Similarly, bankruptcy rules—especially the homestead exemption level—are quite
different across the United States. Morgan, Iverson, and Botsch (2009) present state-
level ratios of the homestead exemption to the state median house price. Since the
model represents the aggregate U.S. economy, I choose the homestead exemption
parameter ϕ as 0.24 that is the average homestead-exemption-to-house-price ratio for
the entire country. Since I use the U.S. economy in the early 2000s as a benchmark, and
since the BAPCPA was enacted in 2005, I set the means test criteria ê as infinite. That
is, every financially troubled household can file for Chapter 7 bankruptcy, regardless
of its income level.
Then, there remain four free parameters: the discount factor β, the default penalty
after filing for bankruptcy φU , the homeowner’s extra utility κ, and the median house
value p̄. I jointly match the annual foreclosure rate of 0.55% (Jeske, Krueger, and
23. States that have adopted recourse mortgages and nonjudicial foreclosure scheme are as follows:
Alabama, Arkansas, Colorado, Washington DC, Georgia, Hawaii, Idaho, Michigan, Mississippi, Missouri,
Nebraska, Nevada, New Hampshire, Oklahoma, Rhode Island, Tennessee, Texas, Utah, Virginia, West
Virginia, and Wyoming.
JISEOB KIM : 19
TABLE 2
STEADY STATE
Data Benchmark
Targeted statistics
Homeownership rate 68% 67.9%
House-value-to-annual-income ratio 2.73 2.73
Annual foreclosure rate 0.55% 0.64%
Annual bankruptcy rate 0.95% 0.92%
Nontargeted statistics
Annual-mortgage-payment-to-house-value ratio 0.06 0.09
Annual-mortgage-payment-to-annual-income ratio 0.14 0.20
Homeownership rate for households with income ≤ 50% 52.3% 61.5%
Homeownership rate for households with income > 50% 84.1% 78.2%
Fraction of households with both types of loans 24% 34.2%
(Avg income with a mortgage)/(Avg pop income) 1.35 1.10
(Avg income with an unsecured loan)/(Avg pop income) 0.87 1.43
Mortgage loan interest rate premium 3.7%p 0.1%p
Unsecured loan interest rate premium 10.9%p 3.4%p
(# of households defaulting only on the unsecured loan)/(# pop) 0.46%
(# of households defaulting only on the mortgage)/(# pop) 0.01%
(# of households defaulting on both loans)/(# pop) 0.44%
Mitman 2013), the average Chapter 7 bankruptcy rate of 0.95% (2001 bankruptcy
rate), the homeownership rate of 68% (average homeownership rate in 2000–04), and
the house-value-to-annual-income ratio of 2.73 (2001 SCF).24 Table 1 summarizes
the model parameters.
3. ANALYSIS OF THE BENCHMARK ECONOMY
In this section, I present the benchmark steady-state economy and examine the
model’s underlying mechanism. Specifically, I analyze the household’s optimal re-
payment, selling, and default decisions, and the unsecured loan and the mortgage
interest rate schedules.
Table 2 presents data and model-generated moments. Through the calibration, I
matched the homeownership rate, the house-value-to-annual-income ratio, the fore-
closure rate, and the bankruptcy rate.
Though I did not directly target them, the model can match several household
finance-related moments. The annual-mortgage-payment-to-house-value ratio and
the annual-mortgage-payment-to-annual-income ratio in the 2001 SCF are 0.06 and
0.14, while the model generates 0.09 and 0.20, respectively. Consistent with the
data, the homeownership rate for high-income households is higher than the rate for
24. The foreclosure rate—both in the data and in the model—is defined by the ratio of foreclosed
households to mortgage holders. The bankruptcy rate is the ratio of Chapter 7 filings to the number
of households. In the model, the bankruptcy rate is the ratio of unsecured loan defaulters (including
households defaulting on both loans) to the population size. The bankruptcy data come from the American
Bankruptcy Institution. The homeownership rate data come from the Census.
low-income households. The fraction of households that have both the unsecured
loan and the mortgage in data (2001 SCF) is 24%, while the model-generated ratio is
34.2%.25 On average, households taking out mortgages tend to have higher income
than the average population, both in the data and in the model. Households that have
the unsecured loan tend to have lower income than the average population in the data,
while they have higher income in the model. In the model, low-income households
would like to take out the unsecured loan to smooth out adverse income shocks, but
they cannot borrow with low interest rates or are rationed from the credit market,
because of the high default probability.26 Instead, homeowners whose income is
higher than renters tend to take out the unsecured loan with rolling over debt, repay
the mortgage, and smooth consumption.27 According to the FRED, the interest rate
spread between the 30-year fixed-rate mortgage rate (credit card interest rate) and
the T-bill rate is around 3.7% points (10.9% points).28 Though the levels differ, the
model can generate a higher spread for the unsecured loan than the mortgage loan.
Among unsecured loan defaulters, 51% of households default only the unsecured
loan; the other 49% of defaulters also fail to repay the mortgage loan. Most mortgage
defaulters also default on their unsecured loan. The number of households that default
on the unsecured loan but repay the mortgage is higher than the number of households
that default on the mortgage but repay the unsecured loan before the financial crisis,
which is consistent with Komos et al. (2012) and Andersson et al. (2013).
3.1 Households’ Repayment, Selling, and Default Decisions

Every household faces idiosyncratic income and house price shocks. Depend-
ing on the realization of shocks, households make their optimal repayment, sell-
ing, and default decisions. For example, when a homeowner has good credit
records in both credit markets, (s)he can choose one of following six options:
{H (G,G) , H D(B,G) , S (G,G) , S D(B,G) , R (G,B)
D , R (B,B) }. Figure 1 presents the homeowner’s
optimal discrete choice depending on the realization of idiosyncratic shocks.
The x-axis is the net financial asset a (saving or borrowing) and the y-axis is the
periodic payment m. When the household has a significant amount of unsecured
debt with a small mortgage payment burden, it sells the house and defaults on the
unsecured loan to relieve its financial tightness. That is, it chooses the value of
S D(B,G) (see the first panel of Figure 1). As the household’s mortgage payment burden
increases, it keeps the ownership of the house and defaults on the unsecured loan
(H D(B,G) ). Since selling the house incurs the transaction cost, the household defaults
only on the unsecured debt and relaxes its budget constraint. In addition, as the
25. I define the unsecured loan as the sum of the credit card balance and lines of credit not secured by
a house.
26. Note that households with a bad credit record in the unsecured loan market are not allowed to
access the loan. However, even households with a good credit rating can possibly be barred from the
market by the endogenously determined credit limit. See Section 3.2 for more details.
27. In the model, the ratio of the renter’s (homeowner’s) income with an unsecured loan to the average
renter’s (homeowner’s) income is 0.77 (1.3).
28. The FRED is the public database published by the Federal Reserve Bank of St. Louis.
JISEOB KIM : 21
Keep & ( , ) (a) Low income, Low house price ( , )

Both default ( ) Mortgage default ( )
Default
( , )
( ) 0.27
( , )
Sell & Repay ( )
Default 0.00
( , )
-6.8
-5.5
-4.2
-2.9
-2.3
-2.0
-1.7
-1.4
-1.1
-0.8
-0.5
-0.2
0.1
0.4
0.7
1.0
1.3
1.6
1.9
2.2
2.5
3.8
5.1
6.4
( )
(b) Low income, High house price ( , )

Mortgage default ( )
Mortgage payment
( , )
Both default ( )
Sell & ( , ) 0.27

Sell ( )
Default
( , ) 0.00
( )
-6.8
-5.5
-4.2
-2.9
-2.3
-2.0
-1.7
-1.4
-1.1
-0.8
-0.5
-0.2
0.1
0.4
0.7
1.0
1.3
1.6
1.9
2.2
2.5
3.8
5.1
6.4
( , )
Both default ( ) (c) High income, Low house price
( , ) 0.27
Repay ( )
0.00
-6.8
-5.5
-4.2
-2.9
-2.3
-2.0
-1.7
-1.4
-1.1
-0.8
-0.5
-0.2
0.1
0.4
0.7
1.0
1.3
1.6
1.9
2.2
2.5
3.8
5.1
6.4
Net ﬁnancial asset
Opmal decision for

( , ) ( , ) ( , ) ( , ) ( , ) ( , )
max{ , , , , , }
FIG. 1. Payment, Selling, and Default Decisions.
mortgage payment burden increases, the household’s home equity decreases, which
means the unsecured loan lender can only recover a small percent of the losses from
the defaulted household. Since defaulting on the unsecured loan becomes less costly,
financially troubled households decide to keep their home. When the household has a
significant mortgage payment burden, it defaults on both types of loans, even though
this incurs huge default costs.
When the household has a large amount of financial asset and mortgage debt,
it tends to default on the mortgage loan. However, households that have a smaller
amount of assets but have high mortgages repay both types of loans. For example,
when the mortgage payment burden is high enough, the household that has assets of
around 1.0 does not default on both loans (H (G,G) ). However, when the household’s
assets increase to above 1.9, it decides to default only the mortgage loan (R (G,B)
D ).
It seems counterintuitive because high-asset households tend to default more for the
given level of the mortgage payment burden. This result comes from the recourse
mortgage scheme. Households that have a significant amount of mortgages would
like to default on the loan and relax their budget tightness. However, when the
household defaults on its mortgage, it has to pay the fraction ξ of lender’s losses
(ξ max{0, A(m) − (1 − χ D ) p}) from its income and assets. Hence, households with
a large amount of financial assets can default on the mortgage and compensate the
lender’s losses. Households that have a smaller amount of financial assets while
having a large mortgage would like to default on the mortgage as well, but they
cannot, because they cannot afford to compensate mortgage lender’s losses. When the
recourse parameter ξ is zero, an increase in the mortgage (monotonically) increases
the probability of mortgage default for each level of the financial asset.29
As the house price increases, households are more likely to sell the house, rather
than keep the ownership (compare the first two panels in Figure 1). At the same time,
the mortgage default region decreases. When the house price goes up, households can
reap the capital gain by selling the house, and wait for the low house price state. As
the household income increases, household’s repayment region increases (compare
the first and the third panels in Figure 1). Since the income process is quite persistent,
households are less likely to default on either the mortgage or the unsecured loan.
Each household makes its optimal discrete choices depending on the realization
of income and house price shocks. Then, financial intermediaries take into account
a household’s optimal behavior, calculate the expected profit while issuing loan
contracts, and propose loan interest rate schedules, as presented in the next subsection.
3.2 Interest Rate Schedules

In this subsection, I present the unsecured loan and mortgage interest rate sched-
ules.30 Each lender calculates the expected profit by issuing a loan contract. If the
lender expects that the borrower is highly likely to default and incur losses, (s)he
charges higher interest rates (or offers lower loan prices).
When the (G, G)-credit homeowner takes out the unsecured loan, the unsecured
loan lender offers the loan price schedule qUH . Let rUH be the unsecured loan interest
rate calculated from the loan price qUH . Figure 2 presents unsecured loan interest rate
schedules rUH . As the household takes out larger amounts of either the unsecured loan
or the mortgage, ceteris paribus, the unsecured loan interest rate schedule increases
(see panels (a) and (b) in Figure 2, respectively). When the household takes out a
large amount of the unsecured debt, it is more likely to default on its loan, leading to
a decrease in the lender’s expected profit, and thus an increase in the unsecured loan
interest rate. When the household has a significant amount of the mortgage payment
burden, this also impacts its unsecured loan default decision. As the mortgage burden
increases, those highly indebted households might default on both types of loans.
29. I analyze the impact of the recourse scheme on mortgage defaults and interest rate schedules in
Appendix D.
30. The unsecured loan interest rate rU can be calculated from the unsecured loan price qU as follows:
qU = 1/(1 + rU ). Similarly, the mortgage interest rate r M can be derived from a unit mortgage bond price
∞
q M as follows: q M = t=1 δ t−1 /(1 + r M )t . That is, the mortgage interest rate r M can be expressed by
1/q M + δ − 1. Hatchondo, Martinez, and Padilla (2014) also used this methodology in calculating the
interest rate on the context of international finance.
JISEOB KIM : 23
(a) (b)
Unsecured loan interest rate ( ) Unsecured loan interest rate ( )
100% 100%
Low house Low income
80% price 80%
Middle income
60% Middle 60%
house price High income
40% 40%
High house
20% price 20%
0% 0%
0.3
0.9
1.4
2.0
2.7
5.1
-6.8
-4.4
-2.4
-1.8
-1.3
-0.7
-0.2
0.00
0.04
0.08
0.12
0.15
0.19
0.23
0.27
0.31
0.35
0.38
0.42
0.46
0.50
Net ﬁnancial asset (a) Mortgage payment (m)
FIG. 2. Unsecured Loan Interest Rate Schedules.
Hence, an increase in mortgage payment burden can also impact unsecured loan
default decisions and interest rates.
When the household has higher income or faces higher house prices, the unsecured
loan rate schedule shifts down. Under the benchmark calibration, income and house
prices are highly persistent. Hence, high-income and high-house-price households
tend not to default on the unsecured loan, leading to a decrease in interest rates.31
These are consistent with default and repayment decisions reported in Figure 1.
Figure 3 presents the mortgage interest rate schedules faced by (G, G)-credit home
G
buyers (r M ) and (B, G)-credit home buyers (r MB ).32 Consistent with unsecured loan
interest rate schedules, households that take out the large amount of the mortgage
face the higher interest rate. In addition, since high-income and high-house-price
households are less likely to default on their mortgages, the mortgage lender offers
lower interest rates.
However, unlike with the unsecured loan rate schedules, an increase in net financial
assets does not always lead to a decrease in the mortgage interest rate schedule (see
panel (c) for r MB schedules). When households have a small amount of assets, an in-
crease in net financial assets leads to an increase in mortgage interest rates. When the
household’s net financial assets are higher than a certain level, an increase in net finan-
cial asset decreases the mortgage interest rate. Though it seems to be counterintuitive,
this nonlinear relationship between net financial assets and the mortgage interest rate
comes from the recourse scheme. As explained in Section 3.1, even households with
a significant amount of net financial assets can default on their mortgages if they
have a large payment burden. Under the recourse scheme, mortgage defaulters must
compensate the certain fraction of lender’s losses. Hence, if the household does not
31. Though not discussed in this paper, the unsecured loan interest rate schedules renters face are also
quite similar to those faced by homeowners. Specifically, unsecured loan rates increase as renters with
lower income take out a larger amount of unsecured loans.
32. The mortgage interest rate r MG (r MB ) is derived from the mortgage price q MG (q MB ). The explicit
formula of the mortgage price q MB is explained in Appendix A.
(a) (b)
Mortgage loan interest rate ( ) Mortgage loan interest rate ( )
14% 14%
Low house Low income
12% 12%
price Middle income
10% Middle 10%
High income
8% house price 8%
6% High house 6%
4% price 4%
2% 2%
0% 0%
0.00
0.04
0.08
0.12
0.15
0.19
0.23
0.27
0.31
0.35
0.38
0.42
0.46
0.50
-6.8
-4.7
-2.5
-2.0
-1.5
-1.0
-0.5
0.0
0.5
1.0
1.5
2.0
2.5
4.7
6.8
(c) (d)
Mortgage loan interest rate ( ) Mortgage loan interest rate ( )
8% 8%
Low income
6% 6% Middle income
High income
4% 4%
2% Low house price 2%

Middle house price
High house price 0%
0%
0.00
0.04
0.08
0.12
0.15
0.19
0.23
0.27
0.31
0.35
0.38
0.42
0.46
0.50
0.00
0.25
0.50
0.75
1.00
1.25
1.50
1.74
1.99
2.24
2.49
3.58
4.66
5.74
6.83
FIG. 3. Mortgage Interest Rate Schedules.
have enough net financial asset to compensate the lender’s losses, it makes the mort-
gage payment by reducing consumption and saving. However, the household tends
to default on the mortgage and becomes free from the mortgage burden, as its net
financial asset increases to compensate lenders’ losses. When the household holds
a significant amount of net financial assets, which makes paying periodic mortgage
payments affordable, the mortgage debtor’s default probability goes down again.
Before moving to policy experiments, three things are worth mentioning. First,
unsecured loan and mortgage interest rate schedules presented in this subsection are
not equilibrium interest rate paths. These loan rate schedules include both the on-
and off-the-equilibrium paths. In other words, based on loan rate schedules (or loan
supply curves), households make their optimal borrowing decisions.
Second, lenders never refuse households’ credit application if they have a good
credit record. However, households with the tarnished credit record are not allowed to
access the credit market. In the real world, lenders have underwriting procedures and
lending guidelines, such as the loan-to-value ratio and the payment-to-income ratio
limits. Based on these rules, some households are not allowed to borrow funds even if
JISEOB KIM : 25
they have a good credit record. In addition, many lenders would not extend credit to
defaulters immediately in practice even if the regulation warrants immediate access.
For simplicity, I do not explicitly consider such household debt–related guidelines
and actual lending practices. I instead model that lenders control the supply of debt
only through the interest rate schedule.
Third, households’ application for credit can be endogenously denied even if they
have a good credit record. If households want take out a large amount of loan, the
interest rate increases (or the loan price decreases) significantly, reflecting the high
default probability. This prevents them from borrowing an indefinite amount of loan.
That is, there exist endogenously determined credit limits for each loan market.33
4. ANALYSIS OF UNSECURED CREDIT POLICIES
In this section, I quantitatively examine how improving access to the unsecured

credit market can impact households’ defaults during the financial crisis. During the
crisis, financially troubled households may strategically default on the mortgage loan,
rather than the unsecured loan to access and preserve the source of liquidity and to
smooth consumption (Komos et al. 2012, Andersson et al. 2013, Chan et al. 2016).
Given this, can we reduce mortgage defaults if we allow households to easily reaccess
the unsecured loan market after they default on it?
To analyze this, I first set the benchmark transition, which represents the U.S.
economy before and after the financial crisis. The timing of the benchmark transition
is as follows. The steady state presented in Table 2 represents the U.S. economy
during the early 2000s. In 2005, the U.S. government enacts the BAPCPA, reducing
the means test criteria ê to the median household income ē. After this, the average
house price unexpectedly declines by 16% from 2007 to 2008, mirroring the U.S.
financial crisis. Market participants expect that the decrease in the average house
price is a permanent shock. At the end of 2008, the average house price unexpectedly
and permanently drops by 13% one more time, contrary to ex ante expectations.34
Following this, there are more no changes in the average house price.
Next, I consider a counterfactual transition where households’ accessibility to
the unsecured loan market changes after the financial crisis. In addition, I consider
an experimental transition where the BAPCPA was not enacted in 2005, making
it easier for households to file for bankruptcy. By comparing these counter-factual
transitions with the benchmark transition, I can normatively analyze how changes
in unsecured credit policies—which affects households’ liquidity accessibility—can
impact short-run mortgage and unsecured loan defaults during the financial crisis.
33. Since the household takes out the unsecured loan by the amount of qU (·)|a |, the credit limit is
defined by min a qU (·)a . Similarly, the credit limit for the mortgage is defined by maxm q M (·)m.
34. According to the Case-Shiller index, the average house price in the United States declined by 16%
in 2007 and 13% in 2008. After this, the house price stabilized for several years and started increase after
2012. Since the financial crisis period is the main focus of this paper, I consider the consecutive 2-year
decline in house prices.
Bankruptcy rate Foreclosure rate

8% 10%
6% 8%
6%
4%
4%
2% 2%
0% 0%
2000 2002 2004 2006 2008 2010 2012 2014 2016 2000 2002 2004 2006 2008 2010 2012 2014 2016
Default only on the unsecured loan / Pop Default only on the mortgage / Pop
2.0% 2.0%
1.5% 1.5%
1.0% 1.0%
0.5% 0.5%
0.0% 0.0%
2000 2002 2004 2006 2008 2010 2012 2014 2016 2000 2002 2004 2006 2008 2010 2012 2014 2016
Default on both loans / Pop Homeownership rate

6% 80%
5%
75%
4%
3% 70%
2%
65%
1%
0% 60%
2000 2002 2004 2006 2008 2010 2012 2014 2016 2000 2002 2004 2006 2008 2010 2012 2014 2016
Benchmark Probability of recovering a good credit record ( u): 0
Data Probability of recovering a good credit record ( u): 1
FIG. 4. Transition Analysis: Unsecured Credit Accessibility.
4.1 Benchmark Transition

In this subsection, I examine how the (benchmark) model can reproduce the data
on the transition. Figure 4 presents the benchmark transition (black solid line) and the
actual data (black circle). In the benchmark, the bankruptcy rate suddenly decreases
after the BAPCPA is enacted in 2005, which is consistent with data. Under the
BAPCPA, households whose income is above the median level cannot file for Chapter
7 bankruptcy. Hence, the bankruptcy rate both in the data and in the model suddenly
decreases.35 Since the enactment of the BAPCPA limits a household’s option to
default, multiple debtors whose incomes are higher than the median level default on
35. Since I model that the BAPCPA is unexpectedly enacted in 2005, I cannot generate the sudden
increase in the bankruptcy rate in 2004. If I model that the BAPCPA is enacted with the preannouncement,
as was done in Athreya et al. (2015), the bankruptcy rate would increase in advance of the actual enactment.
JISEOB KIM : 27
the mortgage loan to relieve their budget tightness. Hence, the mortgage foreclosure
rate slightly increases from 2006 to 2007, consistent with Li, White, and Zhu (2011).
After the enactment of the BAPCPA, high-income households cannot default on
the unsecured loan, leading to a decrease in interest rates faced by high-income
households. With lowered interest rates, high-income renters can buy a house with
the supplementary financing from the unsecured credit market, leading to an increase
in the homeownership rate.36
Starting from 2007, the median house price p̄ unexpectedly decreases for two
consecutive years, as experienced in the United States. The sudden decrease in
the house price increases both the bankruptcy rate and the foreclosure rate. In my
benchmark, the bankruptcy rate increases to 3.7% in 2009, and the foreclosure rate
increases to 5.4% Though there are differences between the benchmark and the
data, the model generates significant defaults only through the house price shock.37
After a sudden decrease in the house price without a change in the average in-
come, the number of home buyers increases enjoying the extra utility from owning
a house. Hence, the average homeownership rate increases in the short run. With
the house price shock, the number of households that default only on the unsecured
loan slightly increases from 0.11% in 2007 to 0.44% in 2009. However, households
that default on both types of loans or only on the mortgage loan increase signifi-
cantly, consistent with Komos et al. (2012), Andersson et al. (2013), and Chan et al.
(2016).38
4.2 Analysis of Unsecured Credit Accessibility

In this subsection, I normatively examine whether easy reaccess to the unsecured
credit market after defaulting on the unsecured loan could reduce household defaults
after the financial crisis. To analyze this, I consider the counterfactual transition as
follows. The timing of the experimental transition is the same as in the benchmark
until 2007. In 2007, the average house price unexpectedly declines. At the same
time, unsecured loan defaulters can immediately access the unsecured loan market
(αU = 1). Under this scenario, households with multiple debts can easily default on
their unsecured loan and immediately reaccess the credit market, which relaxes the
liquidity constraint.39 By comparing the counterfactual transition with the benchmark,
36. Though not reported in this paper, the (model) homeownership rate among households whose
income is above the median level increases to 92% in the short run.
37. In Appendix E, I also consider scenarios where the economy faces unexpected income shocks and
simultaneous income and house price shocks.
38. The proportion of households that default on both loans is 0.45% in 2007, 2.5% in 2008, and
2.81% in 2009. The proportion of mortgage-only defaulters is 0.15% in 2007, 1.23% in 2008, and 1.38%
in 2009.
39. Though it might be unrealistic to model that unsecured loan defaulters can immediately reac-
cess the credit market, it is the scenario in which financially troubled households can access liquidity
in the easiest manner. In Appendix C, I consider a counterfactual scenario where the value of αU in-
creases to 0.5 after the crisis. That is, the unsecured loan defaulter can reaccess the credit market after
2 years.
I can analyze policy directions that could reduce household defaults during the
financial crisis.40
The dashed line in Figure 4 presents the counterfactual transition (αU = 1). When
bad-credit households can recover a good credit rating and access the unsecured loan
without time lags, the mortgage foreclosure rate and the bankruptcy rate both increase
compared to the benchmark. As the value of αU increases, defaulting on the unsecured
loan becomes less costly. This leads to an increase in the unsecured loan default rate.
At the same time, financially troubled multiple debtors are more likely to default
on both types of loans, taking advantage of the chance to access the unsecured
loan market easily. In turn, the mortgage foreclosure rate also increases. Though
households defaulting only on the mortgage decrease compared to the benchmark,
the bankruptcy and the foreclosure rates are amplified when we introduce the debtor-
friendly unsecured credit policy.
When it is more difficult for households to reaccess the unsecured credit market
after defaulting on the unsecured loan (αU = 0), the bankruptcy rate and the fore-
closure rate decrease compared to the benchmark. As the postdefault cost increases,
households are less likely to default on their unsecured loan and on both types of
loans. This leads to a decrease in loan interest rate schedules, which increases borrow-
ing. However, the increase in the default penalty dominates the latter effect, leading
to a decrease in default rates. Limited access to the unsecured credit market leads
some financially troubled households to default only on the mortgage. However, an
increase in the default penalty reduces the number of households defaulting on both
loans, leading to a decrease in the total foreclosure rate.41
My numerical exercise shows that a higher chance to reaccess the unsecured credit
market can amplify the bankruptcy rate and the foreclosure rate. However, if the
U.S. government had made it more difficult for households to reaccess the unsecured
credit market after defaulting on the unsecured loan, default rates of both types of
loans could have decreased significantly.42
4.3 Analysis of Pecuniary Default Costs

In this subsection, I consider a counterfactual transition where the cost af-
ter defaulting on the unsecured loan (φU ) becomes zero after 2007. By reduc-
ing the pecuniary default cost, the budget tightness faced by financially troubled
40. Since household defaults accompany social costs and bad externality, proposing policy guidelines
without incurring significant costs can improve social welfare (Li and White 2009). For example, mortgage
defaults can negatively impact on our real economy (Mian, Sufi, and Trebbi 2015), as well as the academic
performance of students (Been et al. 2011). Though the U.S. government tried to reduce the mortgage
default rate by introducing foreclosure prevention programs, I would like to examine indirect ways of
mitigating the mortgage default rate by adjusting unsecured credit policies.
41. In Appendix C, I also consider a (nonextreme) scenario where the value of αU decreases to 0.05
after the financial crisis. That is, the unsecured loan defaulter can reaccess the credit market after 20
years. Default rates over the transition path are in the middle between the benchmark and the experiment
transition considered in this subsection.
42. In Appendix B, I present the long-run impact of unsecured credit policies. Consistent with re-
sults in this subsection, the bankruptcy rate and the foreclosure rate increase as the unsecured credit
accessibility improves.
JISEOB KIM : 29

15% 10%
8%
10%
6%
4%
5%
2%
0% 0%
2000 2002 2004 2006 2008 2010 2012 2014 2016 2000 2002 2004 2006 2008 2010 2012 2014 2016
8% 2.0%
6% 1.5%
4% 1.0%
2% 0.5%
0% 0.0%
2000 2002 2004 2006 2008 2010 2012 2014 2016 2000 2002 2004 2006 2008 2010 2012 2014 2016
8% 80%
6% 75%
4% 70%
2% 65%
0% 60%
2000 2002 2004 2006 2008 2010 2012 2014 2016 2000 2002 2004 2006 2008 2010 2012 2014 2016
Benchmark Pecuniary default cost for

the unsecured loan ( u): 0
Data
FIG. 5. Transition Analysis: Default Cost.
households will be relaxed. The timing of the experimental transition is the same
as that of the previous subsection, except that the pecuniary cost φU becomes zero
after 2007.
As presented in Figure 5, a reduction in the default cost φU does not help reduce
households’ defaults during the financial crisis. When the value of φU becomes zero,
the value of defaulting on the unsecured loan increases, leading to an increase in the
bankruptcy rate. At the same time, financially troubled debtors with multiple loans
are more likely to default on both types. However, the number of households default-
ing only on the mortgage decreases. Since the cost of defaulting on the mortgage
does not change, households tend to default on the unsecured loan, rather than the
mortgage.

4% 8%
3% 6%
2% 4%
1% 2%
0% 0%
2000 2002 2004 2006 2008 2010 2012 2014 2016 2000 2002 2004 2006 2008 2010 2012 2014 2016
0.8% 3.0%
2.5%
0.6%
2.0%
0.4% 1.5%
1.0%
0.2%
0.5%
0.0% 0.0%
2000 2002 2004 2006 2008 2010 2012 2014 2016 2000 2002 2004 2006 2008 2010 2012 2014 2016

3.0% 80%
2.5%
75%
2.0%
1.5% 70%
1.0%
65%
0.5%
0.0% 60%
2000 2002 2004 2006 2008 2010 2012 2014 2016 2000 2002 2004 2006 2008 2010 2012 2014 2016
Benchmark No BAPCPA
Data
FIG. 6. Transition Analysis: BAPCPA.
4.4 Analysis of the BAPCPA

In this subsection, I analyze impacts of the enactment of the BAPCPA on the
mortgage and unsecured loan default rates. According to Li, White, and Zhu (2011),
the bankruptcy law reform in 2005 raised the cost of filing for bankruptcy, which
led to an increase in the mortgage default rate. They mentioned that “[the] reform
contributed to the severity of the mortgage crisis by pushing up default rates even
before the crisis began.”
Here, I consider a counterfactual transition path where the BAPCPA was not
enacted in 2005. Other components are the same as in the benchmark. As presented
in Figure 6, the enactment of the BAPCPA reduces the bankruptcy rate by 0.4%
points before the financial crisis. In addition, the BAPCPA contributes to an increase
in the foreclosure rate by 0.2% points in 2006–07. Consistent with the prediction
JISEOB KIM : 31
of Li, White, and Zhu (2011), the bankruptcy reform contributes to an increase in
the foreclosure rate by 1.2% points in 2008. However, the benchmark foreclosure
rate in 2009 is lower than the rate without the BAPCPA. As filing for bankruptcy
becomes more difficult, households tend to default on their mortgages more often,
leading to an increase in mortgage interest rate schedules. This reduces the mortgage
borrowing and the mortgage default rate. That is, the enactment of the BAPCPA can
either positively or negatively influence the mortgage foreclosure rate. However, in
the long run, the enactment of the BAPCPA increases the foreclosure rate.43
The bankruptcy reform increases the bankruptcy rate by 1.2% points in 2008 and
0.3% points in 2009. The enactment of the BAPCPA makes it more difficult for
households to default on their unsecured loan, which reduces the bankruptcy rate.
At the same time, however, the difficult process of filing for bankruptcy leads to a
decrease in unsecured loan interest rate schedules, which in turn leads to an increase
in the unsecured borrowing. This motivates households to default on their unsecured
loan, if they are able to do so while rolling over their debt. In the short run, the latter
effect dominates the former effect. However, in the long run, the enactment of the
BAPCPA negligibly impacts the bankruptcy rate.44
5. CONCLUSION
In this paper, I quantitatively analyze impacts of unsecured credit policies on

households’ optimal behavior and default decisions. Before the financial crisis, the
proportion of households defaulting on the mortgage while remaining current on
the unsecured loan was almost the same as the proportion of households current on
the mortgage but defaulting on the unsecured loan. During and after the crisis, the
former ratio became much higher than the latter. Though an increase in the foreclosure
rate was inevitable given the serious and sudden decline in house prices, the U.S.
economy could have mitigated such a high increase in default rates by increasing the
cost for unsecured loan defaults. To analyze this, I introduce a heterogeneous agent
model with the mortgage and the unsecured loan, calibrate it to match moments in
the early 2000s, and compute the transition representing the U.S. economy before
and after the crisis. According to my quantitative analysis, if households could not
easily reaccess to the unsecured credit market after defaulting on the unsecured loan,
both the bankruptcy and foreclosure rates could have decreased significantly in the
short run. However, improving access to the unsecured loan or reducing pecuniary
costs after the default are not effective ways of reducing the default rate. Therefore,
43. The BAPCPA increases the long-run foreclosure rate by 0.16% points.
44. Athreya et al. (2015) quantitatively examined how the enactment of the BAPCPA impacts the for-
mal bankruptcy rate and the informal delinquency rate. Their exercise shows that the BAPCPA significantly
reduces the bankruptcy rate after 2006, which (partly) contrasts with my results. Since they do not consider
the housing and mortgage markets, it is impossible to consider households’ strategic default decisions—
mortgage vs. unsecured credit defaults. However, unlike my paper, they allow households to informally
default (or delinquent) on their unsecured loan, which temporarily relieves their financial burden.
increasing default costs for the unsecured credit could have been an alternative option
to mitigate mortgage defaults during the financial crisis.
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SUPPORTING INFORMATION
Additional supporting information may be found online in the Supporting Infor-

mation section at the end of the article.

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DOI: 10.1111/jmcb.

How Unsecured Credit Policies Influence Mortgage

Before the global financial crisis, the proportion of households defaulting on

JEL codes: E21, E44, G01, K35, R21

BEFORE THE GLOBAL FINANCIAL CRISIS, the proportion of house-

where ct is consumption, and st ∈ {H, R} is an indicator function that is H if a

log( pt ) = (1 − ρ p )log( p̄) + ρ p log( pt−1 ) + νt , (4)

where νt ∼ i.i.d.N(0, σp2 ). In computation, I discretized both shock processes follow-

where r f is the risk-free rate.7

still has a good credit record in the mortgage market.

1.1 Households’ Optimal Problems

P (G,G) (a, e, p) = max u(c, H ) + β E e , p |e, p

H D(B,G) (a, e, p, m) = max u(c, H ) + β E e , p |e, p

household’s home equity (= p − A(m)) net of homestead exemption (ϕp) is larger

c + qUR B (a  , e, p)a  + z( p) + ξ max {0, A(m) − (1 − χ D ) p} = (1 − φ M )e + a. (8)

1.2 Unsecured Loan Lenders’ Problem

UH (1 ) (10)

1.3 Mortgage Lenders’ Problem

GM (1 ) (12)

Parameter Description Value Target/source

3. ANALYSIS OF THE BENCHMARK ECONOMY

3.1 Households’ Repayment, Selling, and Default Decisions

Keep & ( , ) (a) Low income, Low house price ( , )

(b) Low income, High house price ( , )

Sell & ( , ) 0.27

Opmal decision for

FIG. 1. Payment, Selling, and Default Decisions.

3.2 Interest Rate Schedules

FIG. 2. Unsecured Loan Interest Rate Schedules.

2% Low house price 2%

Net ﬁnancial asset (a) Mortgage payment (m)

FIG. 3. Mortgage Interest Rate Schedules.

4. ANALYSIS OF UNSECURED CREDIT POLICIES

In this section, I quantitatively examine how improving access to the unsecured

Bankruptcy rate Foreclosure rate

Default on both loans / Pop Homeownership rate

Benchmark Probability of recovering a good credit record ( u): 0

Data Probability of recovering a good credit record ( u): 1

FIG. 4. Transition Analysis: Unsecured Credit Accessibility.

4.1 Benchmark Transition

4.2 Analysis of Unsecured Credit Accessibility

4.3 Analysis of Pecuniary Default Costs

Bankruptcy rate Foreclosure rate

Benchmark Pecuniary default cost for

FIG. 5. Transition Analysis: Default Cost.

Bankruptcy rate Foreclosure rate

Default on both loans / Pop Homeownership rate

FIG. 6. Transition Analysis: BAPCPA.

4.4 Analysis of the BAPCPA

In this paper, I quantitatively analyze impacts of unsecured credit policies on

Mitman, Kurt. (2016) “Macroeconomic Effects of Bankruptcy and Foreclosure Policies.”

Additional supporting information may be found online in the Supporting Infor-

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P (G,G) (a, e, p) = max u(c, H ) + β E e , p |e, p

H D(B,G) (a, e, p, m) = max u(c, H ) + β E e , p |e, p

c + qUR B (a , e, p)a + z( p) + ξ max {0, A(m) − (1 − χ D ) p} = (1 − φ M )e + a. (8)

UH (1 ) (10)

GM (1 ) (12)