As more homes fall more deeply underwater, it's likely that the stigma of walking away from your home is not as potent as it once was.
The study found that borrowers are more likely to consider walking away from their underwater homes if they believe that many of their peers have done so. However, when negative equity reaches 50 percent or greater, economic benefits of default and moral constraints loosen, raising the likelihood that the borrower will default. For example, if negative equity was at 10 percent, no homeowners would choose to default because of economic costs associated with foreclosure and moral constraints. The study finds that that borrowers largely do not consider strategically defaulting on their loans until negative equity reaches a tipping point. That concern is not unreasonable, but it shouldn't stop us from pursuing principal writedowns for one simple reason: they work.Ī study by researchers at the University of Chicago and Northwestern University, cited by Alan White at Public Citizen, examines the relationship between negative equity and propensity to strategically default, or walk away from your mortgage even if you can afford the monthly payments. A common criticism of principal writedown is that by offering to reduce the amount a borrower owes, it would encourage other borrowers who owe more than their home is worth but could afford to continue making payments to default on their loans so they too could get their principal reduced - or, as economists call it, moral hazard.
Principal writedowns became more relevant - and controversial - than ever when it was recently revealed that Attorneys Generals may include a principal writedown component to their settlement with loan servicers over improperly preparing foreclosure documents. In fact, we bring it up pretty much every time we talk to policymakers, regulators, and the media when they ask us what needs to be done to fix the foreclosure mess.
We at Woodstock Institute have long argued that, in order for loan modifications programs to effectively prevent foreclosures on a broad scale, they need to include a component of reducing the principal owed on underwater homes.
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