The effect of mortgage debt on consumer spending: evidence from household-level data

Abstract

We explore the relationship between owner-occupier mortgage debt and spending using detailed panel data on Australian households. We find evidence consistent with a 'debt overhang effect' – households cut back on their spending when they have higher levels of outstanding mortgage debt. This overhang effect holds even when households' net housing wealth remains constant, implying that households reduce their spending when the gross value of both their debt and assets increases. This suggests that changes in the composition of household balance sheets affect spending, which runs counter to macroeconomic models that combine assets and liabilities into a single measure of net wealth. We find the overhang effect to be pervasive across owner-occupier households and not exclusively driven by households that are financially constrained or that have strong precautionary saving motives. We find evidence that indebted households reduce their spending by more than other households during adverse macroeconomic shocks, such as the global financial crisis, but the negative effect of debt is also pervasive at other times.