To design mortgage modification policies that successfully stem default and allow borrowers to keep their homes, policymakers need to understand why borrowers default. Is it because they’re truly unable to pay, or are they able to pay but have negative equity?
New research finds that both motives were important during the Great Recession, but that ability to pay plays the greater role, accounting for over 60 percent of defaults. Moreover, the analysis—which matches borrowers’ income, employment, and assets with their mortgage characteristics and payment status—shows that cash-strapped borrowers are more than seven times as likely to default as borrowers with strong ability to pay.
These findings indicate that when borrowers suffer an income reduction, mortgage modification policies that reduce monthly payments to an affordable range are likely to be effective in preventing future defaults.