NCPA - National Center for Policy Analysis

Understanding Mortgage Default Decisions and Consumer Credit

July 6, 2015

Faced with declining home values and a challenging labor market, and amid considerable uncertainty about how long the recession would drag on, how did households apportion their limited financial resources to repay loans and preserve access to credit? In their paper, economists from the New York Federal Reserve bank exploit unique panel data derived from credit reports to provide the first comprehensive evidence at the individual level for how homeowners manage credit during periods of financial stress.

Controlling for credit score, it was found that homeowners managed their use of housing and non-housing debt in a way that is broadly consistent with a rational, forward-looking, approach to credit default and to preserving access to credit. Specifically:

  • As home equity declines, homeowners have lower probabilities of credit card and auto loan default.
  • There are lower rates of credit card default and higher rates of housing debt default among those with larger unused credit card limits.
  • Credit card default rates are 18% lower among underwater homeowners if the primary mortgage is non-recourse. For a given income trajectory, greater wealth increases the demand for credit, leading to stronger incentives to preserve credit card borrowing among non-recourse mortgage borrowers.
  • Expected delays in the foreclosure process are associated with increased rates of primary mortgage default among underwater homeowners.
  • Credit card default rates are 57 percent higher among underwater homeowners if the expected delay in the homeowners\' county is at least 9 months, compared to when the delay is up to three months.

The researchers found that mortgage default arises as a substitute for default on other credit accounts, and penalizing mortgage default, such as by repealing anti-deficiency statutes, could lead to higher rates of default on credit cards and auto loans.

Source: Sewin Chan, Andrew Haughwout, Andrew Hayashi, and Wilbert van der Klaauw, "Determinants of Mortgage Default and Consumer Credit Use: The Effects of Foreclosure Laws and Foreclosure Delays," Federal Reserve Bank of New York, June 2015. 

 

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