Mortgage Default and Bankruptcy: Theory and Empirical Evidence
Wenli Li, FRB Philadelphia Michelle J. White, UCSD and NBER
Slide 2
What we do: Examine the interaction of homeowners decisions to
default on their mortgages and file for bankruptcy. We test:
Whether homeowners are more likely to default versus file for
bankruptcy when they gain financially from either, and Whether
homeowners are more likely to default versus file for bankruptcy
when they are liquidity-constrained. We use new data that combines
information on mortgage debt and other types of debt. Previously,
the literatures on mortgage default and bankruptcy were separate
because of lack of combined data.
Slide 3
How are mortgage default and bankruptcy decisions related?
Bankruptcy helps homeowners avoid mortgage default/keep their homes
by discharging unsecured debt. Bankruptcy helps homeowners keep
their homes by delaying foreclosure and allows homeowners to repay
mortgage arrears over five years. But bankruptcy helps homeowners
with high income or high assets less, since they must use repay
from future income and assets. Default helps homeowners preserve
access to credit card loanssome choose default/avoid bankruptcy.
Bankruptcy helps homeowners give up their homes by discharging
deficiency judgments.
Slide 4
Homeowners predicted mortgage default and bankruptcy
decisions
Slide 5
Notes: Diagram is separately calculated for each homeowner. As
shown it assumes that bankruptcy reform is in effect (means test),
mortgage debt is fixed, and unsecured debt is fixed and high.
Homeowners are predicted to default and file for bankruptcy only
when it is in their financial interest. D/B predicted when house
value is low and income is low. (House value is low enough that the
cost of renting < cost of owning.) D/NB predicted when V is low
and Y is high. ND/B predicted when V is higher and Y is high. (Here
the income boundary between B and NB shifts to the right because of
homeowners gains from filing for bankruptcy.) ND/NB applies when V
and Y are both high and when V is very high and Y is low. (Best not
to default because must repay unsec debt from sale proceeds of the
house.)
Slide 6
Same, but some homeowners default due to liquidity
constraints
Slide 7
Notes: Now some additional homeowners default even when it is
against their financial interest b/c V is high. They default
because of liquidity constraints.
Slide 8
Data: We merge three datasets: LPS: large sample of mortgages
with information from the mortgage application, plus monthly
updates on payment and bankruptcy. Equifax: sample of individuals
with information about all types of debt, plus quarterly updates on
payment, credit scores, debt-to-income ratio. HMDA: use it to merge
LPS and Equifax based on date/location/principal of mortgage.
Slide 9
Final dataset: All mortgages originated 2004-2006. They are
followed quarterly until the mortgage is paid off or transferred,
the homeowner defaults or files for bankruptcy, or at the end of
2009. Currently, we include only prime, fixed rate mortgages. Each
quarter, we also have: Amount owed and payment record for second
mortgages, credit card debts, student loans, auto loans, and
installment loans. (Half of each debt if homeowner married.)
Updated credit score and debt-to-income ratio. Income at
origination and homeowners age, sex, marital status.
Slide 10
Specification: We estimate a multi-probit model explaining:
Default/no bankruptcy (aD/NB). No default/bankruptcy (aND/B).
Relative to no default/no bankruptcy (aND/NB). We drop simultaneous
default/bankruptcy because its very rare (aD/B). Main variables of
interest are the predicted decision variables D/NB, ND/B, D/B.
Control variables, quarter and state dummies. Errors clustered by
mortgage.
Add liquidity constraint: Rerun the model with an additional
dummy variable for homeowners who are liquidity-
constrainedcombined debt payments are more than 50% of income. % of
observations that are liquidity- constrained? Everything else
remains the same.
Conclusions: Homeowners mortgage default and bankruptcy
decisions respond strongly to financial benefit. are related. The
two decisions are relatedhomeowners are more likely to file for
bankruptcy. Liquidity constraints make homeowners more likely to do
both.
Slide 17
Future work: Examine subprime mortgages and adjustable rate
mortgages. Compare results when default and bankruptcy decisions
are independent.
