Strategic Mortgage Default: The Effect of Neighborhood Factors

Abstract

This paper studies strategic default — the willingness of a borrower to walk away from a mortgage when the value of the home falls below the unpaid principal balance despite an ability to pay. This study differs from the literature in two fundamental ways: first, we use unique data assets describing the household’s equity position and capacity to carry the debt in addition to credit performance to identify strategic defaulters accurately. Secondly, we address externalities from local foreclosures and other strategic defaults and find that the incidence of strategic default is sensitive to the presence of other nearby strategic defaulters. These results have significant implications for foreclosure and loss mitigation policies employed by servicers and investors.

Keywords: real estate finance