Negative effects of personal bankruptcy filing for homeowners: reduced credit access and lost option value

Cheryl Long

No 959, Proceedings from Federal Reserve Bank of Chicago

Abstract: Focusing on home owners, the paper discusses the reduction in a household?s credit access due to bankruptcy filing and its two effects that may deter a household from filing for bankruptcy. Empirical evidence presented in the paper suggests that a household with a bankruptcy record is about 30% more likely to lose home ownership and consequently the mortgage loans captured in the house, compared to than a similar household without such a record. Since the household is forced to consume at a credit level below their desired level, this translates into an important deterrence effect for households considering bankruptcy filing. The reduction in credit access imposes an additional deterrence effect by eliminating the option to file for bankruptcy in the future when financial damages caused by credit access reduction are smaller. Given that bankruptcy is irreversible and the bankruptcy record is kept in one?s credit history for a long time, the right to file becomes valuable because the household will be better off waiting for the best moment to file when the utility loss due to reduced credit access is the lowest. The value of waiting, or the option value of bankruptcy filing, is also shown to be empirically important. ; Adding these two deterrence effects into the analysis of consumer bankruptcy filing leads to interesting results. A substantial number of households that would benefit from bankruptcy filing according to previous estimates no longer benefit from filing, suggesting that the proportion of American households benefiting from bankruptcy filing may not be as high as previously predicted. The results also have implications on why households file for bankruptcy and why the filing rate has been increasing in the past twenty years.

Keywords: Home ownership; Bankruptcy; Households (search for similar items in EconPapers)
Date: 2005
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Published in Proceedings of a conference held in Washington, DC. (2005 : April 7-8) : a Federal Reserve System Community Affairs Reseach Conference; Promises & Pitfalls: as Consumer Finance Options Multiply, Who Is Being Served and at What Cost?

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