Strategic Defaults Induced by Loan Modifications

Abstract

Some homeowners might intentionally skip mortgage payments that they can afford to be eligible for mortgage modification programs, such as Home Affordable Mortgage Program (HAMP). We use a natural experiment to investigate such strategic behavior. We find that the modification program not only substantially increases the default rates among borrowers who were current in their loan payments, but also dramatically decreases the cure rate of those already in payment delinquency before the settlement, and the latter venue has been largely overlooked in the literature. Evidence from our base sample indicates that, four months after the modification announcement, modification-induced strategic default is about nine percentage points, on a base default rate of thirty percent. Further, modification-induced strategic defaults appear to be quite widespread and more severe among more risky loans.

Keywords: Loan modification, mortgage modification program, strategic default

JEL Classification: G18, G21