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Breaching the Mortgage Contract: The Behavioral Economics of Strategic Default

Posted by on Wednesday, October 26, 2011 in Articles, Volume 64, Volume 64, Number 5, Volumes.

Underwater homeowners face a quandary: Should they make their monthly payments as promised or walk away and save money? Traditional economic analysis predicts that homeowners will strategically default (voluntarily enter foreclosure) when it is cheaper to do so than to keep paying down the mortgage debt. But this prediction ignores the moral calculus of default, which is arguably much less straightforward. On the one hand, most people have moral qualms about breaching their contracts, even when the financial incentives are clear. On the other hand, the nature of the lender-borrower relationship is changing and mortgage lenders are increasingly perceived as remote, profit-obsessed entities undeserving of moral concern. In the studies reported here, I tease out three distinct psychological effects of this perception, including the erosion of reciprocity norms, an increase in social distance, and the destigmatization of foreclosure. The results have ramifications for current debates about securitization and modification of mortgage loans.