Is There a Puzzle in Underwater Mortgage Default?

Lara Loewenstein, Paul Willen, Yuxi Yao () and David Hao Zhang

No 25-22, Working Papers from Federal Reserve Bank of Cleveland

Abstract: A recurring question in the mortgage default literature is why underwater default is rare relative to model predictions. We find that one answer is miscalibration of flow payoffs. We build a novel, detailed quantitative model of mortgage default and find that realistic rent dynamics plus mild levels of default costs are sufficient to eliminate negative-equity strategic default. We present further empirical results supporting our model's focus on flow payoffs. Our model addresses the underwater mortgage default puzzle, offers more realistic interpretations of policy consequences, and reinforces the theoretical effectiveness of cash-flow-based interventions.

Keywords: mortgage default; strategic default; household balance sheets; household decision making (search for similar items in EconPapers)
JEL-codes: D15 G51 R30 (search for similar items in EconPapers)
Pages: 62
Date: 2025-09-25
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Working Paper: Is There a Puzzle in Underwater Mortgage Default? (2025)
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DOI: 10.26509/frbc-wp-202522

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