Recent literature has questioned the effect of high leverage on mortgage outcomes, primarily focusing on mortgage default and foreclosure. In this study, we explore the relationship between high leverage and a different mortgage outcome—the willingness of a borrower to pay the full listing price for a home. In particular, we examine the extent to which FHA insurance moderates the relationship between high leverage and willingness to pay the asking price for a home.  

High-leverage borrowing (e.g. low down payment) may be associated with an increased price paid for durable goods, as borrowers who are highly leveraged may be less sophisticated in financial transactions and less likely to negotiate (Asabere & Huffman, 2008; Ben-David, 2013). For example, Ben-David finds that highly leveraged mortgage borrowers are more likely to pay the full asking price for their homes, resulting in house prices that are 3.4% higher than the market price. This increase can be significant, particularly when housing markets are tight, potentially exacerbating the risk of mortgage default for highly leveraged borrowers.  Given that FHA borrowers tend to be highly leveraged, it might stand to reason that they would also be more willing to pay full price for their homes. 

However, we suggest that FHA insurance may moderate the effect of willingness to pay in two important, but conflicting directions. On one hand, FHA loans tend to involve additional transaction costs (e.g. documentation and inspections) that may make sellers less willing to accept less than full price offers, thus resulting in increased probability of paying full listing price among FHA borrowers, relative to other highly leveraged non-FHA borrowers. On the other hand, the additional information obtained through the FHA origination process (e.g., inspections, accredited appraisals) may equip less sophisticated borrowers with more information about the true quality of the home and thus make them more likely to negotiate down from the full asking price.

To explore the potential FHA effect, we employ a unique dataset on approximately 100,000 MLS individual transactions data of single-family homes in Suffolk County, NY from 2003 to 2012 that includes listing price, sales price and housing characteristics, combined with Home Mortgage Disclosure Act (HMDA) data on individual borrowers, including an indicator for whether or not the mortgage had FHA insurance. This rich data source allows us to identify various factors associated with the resulting negotiated sales price, defined as the sales price as a percent of the full listing price. To identify the FHA effect, we exploit the FHA loan limit threshold- set exogenously by federal policy each year. Specifically, we employ a regression discontinuity design to identify the effect of high leverage on the negotiated sales price for borrowers above and below the FHA threshold.  Our findings have important implications. Systematic overpayment of highly leveraged borrowers can exacerbate house price risk, and thus risk of mortgage default. Furthermore, identifying the moderating effect of FHA insurance for highly leveraged borrowers is informative for future housing policy.