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What’s at Stake? Understanding the Role of Home Equity in Flood Insurance Demand

Authors: Philip Mulder and Yanjun Liao

The consequences of climate change will depend on homeowners’ incentives to manage their risk. A new Working Paper shows that low home equity distorts borrowers’ demand for flood insurance by shifting their risk to lenders and federally backed mortgage purchasers. To isolate the causal effect of home equity on disaster insurance demand, the authors study flood insurance take-up over the housing boom and bust across markets with different price dynamics. Insurance take-up follows rising and falling home equity. Mechanism tests suggest that mortgage default acts as implicit insurance for borrowers with low home equity. Consequently, leveraged households do not fully internalize their climate risk.