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At what point do borrowers who owe more than their homes are worth decide to stop paying the mortgage?

A new study from economists at the Federal Reserve Board aims to answer that question. The research found that the median borrower who “strategically” defaults doesn’t walk away from the mortgage until the amount owed exceeds the value of the home by 62%.

The study is bad news for the mortgage industry in that it backs up the idea that a growing share of borrowers are walking away from loans. Concerns are mounting among lenders and investors that some borrowers who owe far more than their homes are worth are now choosing not to pay mortgages that they can afford.

But the silver lining here is that it suggests a rather high threshold for borrowers to walk away.

“The fact that many borrowers continue paying a substantial premium over market rents to keep their homes challenges traditional models of hyper-informed borrowers” choosing to simply walk away, the authors write. The results suggest “that borrowers face high default and transaction costs” that make strategic defaults less widespread than they might otherwise be.

The study examined borrowers in Arizona, California, Florida and Nevada who bought homes in 2006 with no money down. Nearly 80% of those borrowers had defaulted by September 2009. The authors then attempt to estimate and separate out defaults caused by job loss and other income shocks from those that had been spurred simply by negative equity.

Nearly 80% of all defaults in the sample resulted from the traditional combination of income shocks and negative equity. But for borrowers that had a loan-to-value ratio of 150%, half of all defaults were strategic defaults, driven purely by negative equity.  complete story

Source: Wall Street Journal Blog

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