Mortgage Market Induced Booms and Busts in the Housing Market in a Modified DiPasquale-Wheaton Model

Abstract

In this paper, we offer a nontechnical pedagogical tool that demonstrates the interrelationship between the mortgage market and the housing market. While the importance of the mortgages in the housing market is well established in the literature, an instructive model is still needed. We present a novel and straightforward extension of the DiPasquale and Wheaton (DPW) model, with a price-rent (PR) ratio that incorporates the loan-to-value (LTV) ratio. In our modified DPW model, the LTV adjusted PR ratio allows for an explicit analysis of the opposing effects of lending gain and risk pricing on the user costs of housing. Moreover, the model highlights how changes in the mortgage market may contribute to booms and busts in the markets for both owner-occupied and rental housing.