Breaking the Commitment Device

The early 2000’s witnessed a large increase in the liquidity of housing, as home equity withdrawal became cheaper and easier due to technological advancements and deregulation. This paper investigates the impact of cheaper home equity withdrawal using a life cycle model of consumption, housing, and wealth accumulation. We evaluate the claim that housing has traditionally acted as a savings commitment device, but that recent innovations in home equity withdrawal have broken the commitment benefit of homeownership. The model is estimated using household data on consumption and wealth from the PSID, then validated using a quasi-experiment in Texas, where cash-out refinancing was suddenly legalized in 1998. The estimated model shows that there exists a tradeoff to easier home equity withdrawal, as greater liquidity helps households smooth consumption across income shocks, but hurts households by making it more difficult to accumulate wealth in the first place.

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