Phoenix Homes and Foreclosures: Default on mortgage loans – the moral, social, and strategic implications

Tuesday, September 15, 2009

Default on mortgage loans – the moral, social, and strategic implications

The moral, social, and strategic implications of default on mortgage loans

The National Bureau of Economic Research (NBER) recently published research regarding default on mortgage loans written by authors Luigi Guiso, Paola Sapienza, and Luigi Zingales. They used survey data to study American households' propensity to default on mortgage loans when the value of their mortgage exceeds the value of their house -- even if they can afford to pay their mortgage. They called this a “strategic" default on mortgage. They found that:

26% of people who default on mortgage loans do so under a “strategic" default. That means the homeowner chooses to 'walk away' even though they can make the payments. This could be because the borrower decides not to "throw good money after bad."
No household would default on mortgage loans if the equity shortfall is less than 10% of the value of the house
17% of households would default on mortgage loans -- even if they can afford to pay their mortgage -- when the equity shortfall reaches 50% of the value of their house
If equity was a negative $50,000, 20% of those who default on mortgage loans think it is not morally wrong to walk away, whereas only 7% of the "moral" ones would default on mortgage loans.
If the negative equity is increased to $100,000, 22% of the "moral" ones would default on mortgage loans. At $200,000 upside-down, 37% said they would default on mortgage loans even though they thought it was morally wrong.
The most important variables in predicting strategic default on mortgage loans are moral and social considerations. People who consider it immoral to default on mortgage loans are 77% less likely to declare their intention to default on mortgage loans, while people who know someone who defaulted are 82% more likely to declare their intention to default on mortgage loans.
The willingness to default on mortgage loans increases with the proportion of foreclosures in the same ZIP code, seemingly because social stigma associated with default on mortgage loans become more common.