Why do Borrowers Default on Mortgages?

Abstract

There are three prevailing theories of mortgage default: strategic default (driven by negative equity), cash flow default (driven by negative life events), and double-trigger default (where both negative triggers are necessary). It has been difficult to test between these theories in part because negative life events are measured with error. We address this measurement error using a comparison group of borrowers with no strategic-default motive. Our central finding is that only 6 percent of underwater defaults are caused exclusively by negative equity, an order of magnitude lower than previously thought. We then analyze the remaining defaults. We find that 70 percent are driven solely by negative life events (i.e., cash flow defaults), while 24 percent are driven by the interaction between negative life events and negative equity (i.e., double-trigger defaults). Together, the results provide a full decomposition of the three theories underlying borrower default and suggest that negative life events play a central role.

Moral Hazard versus Liquidity in Household Bankruptcy

“…(2010), Foote et al. (2010), Foote and Willen (2018), Ganong and Noel (2023)). Additionally, it can help explain why 15 times as many households would financially benefit from bankruptcy than the number that actually file (White (1998)).…”

“…(2017), Agarwal et al. (2017), Ganong and Noel (2020), Ganong and Noel (2023), and Agarwal et al. (2023).…”

“…Waiting until circumstances become sufficiently bad indicates that, by revealed preference, households have a strong aversion to bankruptcy. This aversion can help explain the "double-trigger" theory of default, which posits that both a large payoff and adverse events reducing liquidity are necessary to induce default (Elul et al (2010), Foote et al (2010), Foote and Willen (2018), Ganong and Noel (2023)). Additionally, it can help explain why 15 times as many households would financially benefit from bankruptcy than the number that actually file (White (1998)).…”

“…However, there is a lack of consensus on the relative strength of strategic versus liquidity default motives. For evidence of strong strategic motives, see Mayer et al (2014), Haughwout, Okah, andTracy (2016), and ; for strong liquidity motives, see Scharlemann andShore (2016), Gerardi et al (2017), Agarwal et al (2017), Ganong and Noel (2020), Noel (2023), andAgarwal et al (2023). Results for delinquency do not obviously generalize to bankruptcy.…”

Mortgage Securitization Dynamics in the Aftermath of Natural Disasters: A Reply

“…In the mortgage market, evidence suggests a higher probability of loan delinquency and default risk in the aftermath of such shocks (Ratcliffe et al 2020, Issler et al 2021, Holtermans et al 2022, Biswas et al 2023, Ho et al 2023, Ouazad 2022a. Hikes in insurance premia and losses of earning opportunities (Indaco, Ortega & Taspinar 2021) may cause cash flow shocks that are one of the triggers (one of the double hurdles) of mortgage delinquencies (Ganong & Noel 2023). The increased probability of delinquency and foreclosure may be higher if the spatial correlation of the shock is such that many neighboring home owners are simultaneously considering 11 The finance literature suggests that ambiguity is priced (Brenner & Izhakian 2018).…”