This article examines the impact of state bankruptcy homestead exemptions on mortgage application outcomes. The empirical analysis controls for endogeneity problems by focusing on 55 urban areas that cross state borders using the Home Mortgage Disclosure Act files from 2001 to 2008. The results indicate that holding the loan‐to‐value ratio constant, a more generous homestead exemption encourages borrowers to buy more housing and take out larger mortgages. However, holding house value constant, a more generous homestead exemption discourages mortgage borrowing and results in more home equity. Moreover, benefits of the homestead exemption outweigh the costs of it to mortgage lenders.