Understanding the effect of credit constraints on housing prices is important for analysing the economy, as
well as for setting monetary policy and mortgage lending rules. The focus of this paper is the required down
payment on a mortgage, which is usually referred to as a deposit in Australia. One difficulty facing researchers
on this topic is that credit conditions can change for a variety of reasons and tend to change at the same time
as other factors that affect the housing market. To get around this difficulty, some researchers conduct
controlled survey experiments that ask people how much they would be willing to pay for a home under
different conditions.

In one such survey conducted in the United States, people were asked to imagine they are planning to move
and have found a home they would like to live in. They were then asked how much they would be willing to
pay for the home under different credit conditions. By varying the required down payment and mortgage
rate, their responses showed the effects of changes in these conditions. In response to lowering the required down payment on a mortgage from 20 per cent to 5 per cent, people raised their willingness to pay for a
particular home by around 16 per cent on average. However, there were large differences in the effects
across different demographics. In particular, wealthier people tended to increase their willingness to pay by
less in response to a lower required down payment and less wealthy people increased by more.

This paper further analyses the results of the survey experiment.

How is the survey data used?

In any market, the price is not determined by the average change in willingness to pay, but by the change in
the willingness to pay of the ‘marginal buyer’. The marginal buyer is the person who would no longer buy if
the price was just a little bit higher. The marginal buyer’s willingness to pay coincides with, and sets, the

This paper uses the experimental data to build housing demand curves for the different down payment
scenarios. Along with an inference about supply, these demand curves allow the marginal buyer to be
identified, which gives the effect on price. Overall, I find that the response of the marginal buyer (and thus
the price) to a reduction in the required down payment is much smaller than the average response. The large
increases that push up the average tend to come from households that are not willing to pay close to the
market price because they are the most constrained by the required down payment.
What have we learned?


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The overall message is that housing prices respond a little to lower down payment requirements, but
probably not enough to drive housing price booms.

Previous research on this topic has been split. Quite a bit of research, including the paper by the economists
who ran the survey experiment, argues that the response of prices to lower down payment restrictions is
large and can drive the housing market. Another body of research argues the opposite on the basis that down
payment restrictions are not binding for the wealthier households that determine prices. I find that
somewhere in between these two views is likely to be right; the marginal buyer that sets prices does respond
to changes in down payment requirements, but not as much as the average household.

Originally published by Tom Cusbert, RBA