DP7352 Moral and Social Constraints to Strategic Default on Mortgages

Author(s): Luigi Guiso , Paola Sapienza , Luigi Zingales

Publication Date: July 2009

Keyword(s): foreclosure , moral constraint , mortgage , social constraint , strategic default

JEL(s): D12 , G01 , G18 , G21 , G33

Programme Areas: Financial Economics

Link to this Page: www.cepr.org/pubs/dps/DP7352.asp.asp

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 at 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 is likely to derive from a contagion effect that reduces the social stigma associated with default as defaults become more common.