Mortgage Default with Positive Equity

• Departmental Seminar

Date and Location

Wednesday, March 4, 2015, 3:30 PM - 5:00 PM
2005 Plant and Environmental Sciences

Abstract

Over 80% of defaulting homeowners have positive equity in normal times. This paper develops a structural model of mortgage default in which selling a house takes time, which causes some homeowners to default even with positive equity. Calibrating the model with a standard income process, augmented with “disastrous” shocks, this paper shows that the considerable equity of many defaulters goes beyond what income shocks alone can explain. Including divorce and family size in the model allows it to match the aggregate default rate and the distribution of equity among defaulters. The estimated model suggests that recourse (which allows lenders to seize the assets of underwater defaulters) is ineffective and perhaps counterproductive, consistent with empirical research.