Why Do Borrowers Default on Mortgages? Evidence from High-Frequency Data

Pascal Noel, Neubauer Family Assistant Professor of Finance

There are two prevailing theories of borrower default: strategic default -- when debt is too  high relative to the value of the house -- and ability-to-pay -- when payments are too high relative to available resources. Using monthly administrative data on income and mortgage default, we propose to develop a new methodology to calculate what fraction of defaults are strategic, in the  sense that the borrowers are able to pay their mortgage but choose not to. In preliminary work, we find that underwater and abovewater borrowers experience the exact same change in income in the months before default. We argue that this is consistent with the ability-to-pay theory explaining all defaults and the strategic theory not accounting for any defaults. These results suggest that debt restructuring programs should focus on liquidity provision rather than principal reduction, and that the moral hazard costs of policies designed to help borrowers overburdened with debt are low.

Why do Borrowers Default on Mortgages, (Peter Ganong), The Quarterly Journal of Economics (2023), 1001-65.