["Economic Record, EarlyView. ", "\nWe highlight the importance of high and low states of household indebtedness for the transmission of monetary policy in Australia over the period 1994Q1–2019Q3. Working with a state‐dependent local projection model, we find that the dynamic effects of monetary policy shocks depend on household‐debt conditions: In the low debt state, output, investment, house prices and the household debt‐to‐GDP ratio strongly react to monetary policy shocks, while the responses of these variables are muted in the high‐debt state. Simulations from a stylised theoretical model show that high indebtedness triggers binding collateral constraints that shut off the home equity loan channel, thereby attenuating the consumption response to an interest rate shock. Our results suggest that (i) the home equity channel is active when household debt is moderate, but inactive when debt is high and (ii) this channel played a key role in the transmission of monetary policy in Australia over the sample period, potentially accounting for the diminished effectiveness of monetary policy under high household debt conditions.\n"]