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Moral and Social Constraints to Strategic Default on Mortgages by Luigi Guiso, Paola Sapienza, Luigi Zingales – #15145 (AP CF)

Abstract:

We use survey data to study American households’ propensity to default when the value of their mortgage exceeds the value of their house even if they can afford to pay their mortgage (strategic default). We find that 26% of the existing defaults are strategic.

We also find that no household would default if the equity shortfall is less than 10% of the value of the house. Yet, 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.

Besides relocation costs, the most important variables in predicting strategic default are moral and social considerations. Ceteris paribus, people 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. That moral attitudes toward default do not change with the percentage of foreclosures in the area suggests that the correlation between willingness to default and percentage of foreclosures is likely to derive from a contagion effect that reduces the social stigma associated with default as defaults become more common.

We had over 20% equity in our home. Then the crisis struck. By the time we sold our house after 14 months on the market, we were underwater by 5% before expenses. Were we moral? We did impose a drop-dead date for us to stop making payments of sometime this summer. As luck would have it, we did not have to test our fortitude. Funny thing is, we are happy for having lost only $100,000.

2 Responses to “Moral and Social Constraints to Strategic Default on Mortgages”

  1. Nate says:

    I’m really happy that you posted this. I don’t think I would have seen it elsewhere.

  2. Jim Stout says:

    Here is the September 19, 2009 follow-up article on Strategic Default http://tinyurl.com/l56fyd

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