Household's optimal mortgage and unsecured loan default decision

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Abstract

How do households make optimal borrowing and default decisions when they have the option to borrow in multiple ways? In this paper, I analyze households' optimal mortgage and unsecured loan borrowing and default decisions in the context of the recent recession. I model households as able to default on mortgage debt to walk away from capital losses, at the price of foreclosure. However, a household can also default on unsecured debt to maintain its home, in exchange for a longer exclusion from credit markets following default. Depending on the costs of each alternative, financially constrained households exhibit heterogeneity in optimal default decisions.Next, I analyze how mortgage loan modification policies, after a sudden drop in house prices, affect household choices in the mortgage and unsecured loan markets. The quantitative exercise shows that the government-driven mortgage modification program, initiated in 2009, reduces the mortgage default rate by 0.27% points. However, this increases the unsecured loan charge-off rate by 0.66% points.

Original languageEnglish
Pages (from-to)222-244
Number of pages23
JournalJournal of Macroeconomics
Volume45
DOIs
Publication statusPublished - 2015 Sep 1

All Science Journal Classification (ASJC) codes

  • Economics and Econometrics

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