Mortgage equity withdrawal, risk preferences and financial capability

Presenter: Vivien Burrows, University of Reading

Mortgage equity withdrawal provides an attractive alternative to unsecured borrowing for homeowners. It provides access to funds to smooth consumption in response to adverse shocks, to pay off debts or reinvest, and is generally available on more favourable terms than unsecured borrowing. However it also exposes households to additional sources of risk: borrowing against housing equity increases household exposure to house price volatility and the costs of failing to keep up with repayments can be substantial. It is therefore important to understand what drives this decision, and in particular how it relates to households’ financial competence. Existing household-level studies of the equity withdrawal decision have focused on the impact of consumption-smoothing and financial efficiency motives. This paper uses data from the British Household Panel Survey and the Understanding Society survey to analyse the impact of individual risk preferences and financial capability on this decision. The results suggest that whereas individual risk preferences have little impact, a higher degree of financial capability reduces the likelihood that households will resort to home equity borrowing, and therefore that it is households that are more at risk of financial stress that are likely to tap into their housing equity. These findings have potentially important implications for policies focusing on financial education and regulating information provided by banks and other financial institutions.