Could Mortgage Defaults Snowball?

A new study is out showing that homeowners hopelessly behind on their mortgage payments will walk away from their mortgages if they see a neighbor doing the same thing.

What other “profile tendencies” do strategic defaulters show? Three college professors offer a unique look.

The three academics — Luigi Guiso, Paola Sapienza and Luigi Zingales — have published a groundbreaking study on not only who opts to walk away from a mortgage, but why. The study, entitled Moral and Social Constraints to Strategic Default on Mortgages (published in June 2009 by the National Bureau of Economic Research) sets out to discover the conditions that force homeowners to default on a home loan.

The study found the following:

  • When the value of a mortgage exceeds the value of the house, homeowners begin to show a willingness to default on their mortgage even if they can afford the loan, and especially when home values have fallen by 15% or more.
  • Homeowners rarely default if the negative equity in their home is 10% or less. But once that reaches 15%, the tendency to walk away from a mortgage increases significantly. Nearly one in five individuals would strategically default if the house was worth 50% less than their mortgage balance.
  • 25% or more of recent mortgage defaults could be considered "strategic," rather than an inability to make monthly payments (meaning the homeowner voluntarily walks away from the mortgage).
  • Homeowners who consider it immoral to default are 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 willingness to default increases nonlinearly with the proportion of foreclosures in the same ZIP code,” the paper states.

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