Foreclosures aren't only due to homeowners facing a cash crunch. One out of four defaults on mortgage loans is “strategic,” a new study says, due to a mortgage's value exceeding the value of a house even if the homeowner can afford to pay.

Strategic default is most likely when home values have fallen by more than 15%, according to the study by authors of the Financial Trust Index, a joint project of the University of Chicago's Booth School of Business and Northwestern University's Kellogg School of Management. (Read the paper here by authors Northwestern's Paola Sapienza, Chicago's Luigi Zingales and Luigi Guiso of the European University Institute.)

The researchers found that homeowners start to default once their negative equity passes 10% of the home's value. After that, they “walk away massively” after decreases of 15%. About 17% of households would default - even if they could pay the mortgage - when the equity shortfall hits 50% of the house's value, they found.

"Housing policy under the current administration has focused on reducing households' cash flow problems in response to the housing crisis, but no one has addressed the negative equity issue as part of public policy regarding housing," Sapienza said.

The research is based on homeowner surveys, which also considered moral and social factors involved. People who said it was immoral to default were 77% less likely to declare their intention to do so, the authors write, while those who know someone who defaulted were 82% more likely to say they would default themselves.

"Our research showed there is a multiplication effect, where the social pressure not to default is weakened when homeowners live in areas of high frequency of foreclosures or know others who defaulted strategically,” Zingales said. “The predisposition to default increases with the number of foreclosures in the same ZIP code.”

Among the other findings:

• People under 35 years and over 65 said were less likely to say it was morally wrong to default, compared to middle-aged respondents.
• People with a higher education and African-Americans are less likely to think it's morally wrong to default, while respondents with higher incomes were more likely to think it's morally wrong.
• Republicans and Democrats showed little difference in moral views of strategic default, while independents were less likely to say defaulting is immoral.
• People who supported government intervention to help homeowners were 12 percentage points less likely to say strategic default is immoral, the authors found.

See and Post Comments