Deficiency judgments and borrower maintenance: Theory and evidence

It is well known that when property rights to an asset are divided, individ ual rightholders may not have adequate incentives to invest in proper maint enance. In this paper, we examine how mortgage laws affect the nature of th e lender's claim to the house, and how that claim in turn affects the incen tives of borrowers to invest in home maintenance. The specific law that we examine concerns the right of lenders to pursue a borrower's nonhousing wea lth in the event of default if the value of the house is less than the mort gage balance. Most states allow lenders to collect such "deftciency judgmen tal" while others either prohibit, or make it difficult to obtain them. The theoretical model developed in this paper predicts that borrowers will mai ntain at a higher rate when lenders are allowed to seek deficiency judgment s, Intuitively, when borrowers' nonhousing wealth is at risk, they have an incentive to invest more in maintenance in order to reduce the likelihood t hat the value of the property will fall below the mortgage balance. We atte mpt to measure this effect using data on household maintenance obtained fro m the American Housing Survey along with information on differences in mort gage laws across states. We estimate a three-equation simultaneous system r elating maintenance expenditures, house value, and mortgage rates. The resu lts provide confirmation that variation in mortgage laws affect homeowner m aintenance in the manner predicted by the theory. (C) 2000 Academic Press.