Timothy McMahon
Dr. Muhammad Nuwaz
The Financial Crisis of 2007-2009 ended with two broader lessons, (i) the connection between personal debt and mortgage application outcome and (ii) the evidence about credit score and personal debt as a process to discourage the subprime mortgage. Growing amounts of personal debt such as credit cards, student loans, auto loans, and/or already mortgages can affect mortgage application as well as approval rates because lenders evaluate the individual’s mortgage application using the debt-to-income ratio (DTI) and use this as a major determining factor in the approval or rejection of the mortgage applications. From this context, this study uses the cross-section data from the 2022 wave of Survey of Consumer Finances (SCF) and analyzes the impact of personal data on mortgage applications. The findings show that the probability of applying for and having a second mortgage increases for those individuals who already have a mortgage loan. The evidence further supports that individuals with student loans have a better credit history which contributes positively and significantly to increasing the probability to apply for a mortgage. Similar evidence exists for other small components of personal debt such as auto loans and credit card debt. Additionally, financial literacy among households, measured by three universal questions related to interest rate knowledge, inflation knowledge, and risk component significantly contributes positively to the mortgage application process. This study also explores the joint impact of various categories of personal debt and financial literacy and concludes with a positive and significant impact on mortgage applications. This research opens a new horizon in the personal finance literature and concludes that households should generate small amounts of debt as a process to develop their credit score for mortgage applications.
Keywords: Personal Debt, Financial Literacy, Mortgage, and Probit Model
JEL Classification: G51, G53