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Affordability, Financial Innovation, and the Start of the Housing Boom

Working paper #822
Jane K. Dokko, Benjamin J. Keys and Lindsay E. Relihan

At their peak in 2005, roughly 60 percent of all purchase mortgage loans originated in
the United States contained at least one non-traditional feature. These features, which allowed
borrowers easier access to credit through teaser interest rates, interest-only or negative
amortization periods, and extended payment terms, have been the subject of much
regulatory and popular criticism. In this paper, we construct a novel county-level dataset to
analyze the relationship between rising house prices and non-traditional features of mortgage
contracts. We apply a break-point methodology and find that in housing markets with
breaks in the mid-2000s, a strong rise in the use of non-traditional mortgages preceded the
start of the housing boom. Furthermore, their rise was coupled with declining denial rates
and a shift from FHA to subprime mortgages. Our findings support the view that a change
in mortgage contract availability and a shift toward subprime borrowers helped to fuel the
rise of house prices during the last decade.

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