More than one quarter of mortgage defaults are strategic — when a borrower chooses to default because the property that secures the loan is worth less than the remaining balance of the mortgage, according to a white paper (available to download here) written by a trio of university scholars. The decision to strategically default isn’t as simple as the borrower’s ability to make his mortgage payments or the extent of a home’s negative equity. There are moral and social considerations to take into account, Luigi Guiso, Paola Sapienza and Luigi Zingales wrote in “Moral and Social Constraints to Strategic Default on Mortgages.” The report used an opinion survey to gauge consumer responses to a number of strategic default scenarios. The survey found no household would default if a borrower’s equity shortfall is less than 10% of the value of the house, but 17% of households would default, even if they can afford to pay their mortgage, when the equity shortfall reaches 50% of the value of their house. But borrowers who said it was immoral to default were 77% less likely to declare their intention to do so, while people who know someone who defaulted are 82% more likely to declare their intention to do so, the study said. The study cites Zillow.com research that said 22% of households are underwater in the mortgage. But one factor that the study found did not contribute to a borrower’s decision to strategically default is the number of other defaults in the borrower’s ZIP code, but the lessening of social stigmas toward default is a result of a contagion effect as increasingly more borrowers default across the country. But social and moral factors are not the only considerations. “Assuming that a homeowner will default as soon as his home equity becomes negative is clearly wrong,” the study said. “Negative equity may be a necessary conditions to trigger default, but it is not a sufficient one.” Instead, the study found, the likelihood of strategic default increases as the level of negative equity increases. The study is the latest argument is what is becoming an increasingly more important issue to the mortgage industry. Commentary by information and financial services executive Thomas Showalter in the August 2009 edition of HousingWire magazine argues that the more borrowers are inclined to stay in their home even when they are in negative equity. As in the white paper, Showalter believes borrowers strictly in a negative equity position are less likely to default. He argues that borrowers that are more willing to stick with a mortgage are the ones who are most likely to benefit from a mortgage modification, while borrowers more likely to default will still carry that sentiment, even if the borrower receives a mortgage modification. Showalter said the results raise the question on the effectiveness of mortgage modifications. It’s hard to track strategic defaults, as borrowers who do make the decision to strategically default are more inclined to act as a truly distressed borrower. An upcoming edition of HousingWire will delve into this topic and explore both sides of the strategic default argument. Write to Austin Kilgore.
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