Emotion Drives Many Defaults

BY JAMES R. HAGERTY

People often fall in love with their homes based on some charming but impractical feature or other. Now, increasing numbers of homeowners are abandoning their nests for similarly emotional--and sometimes irrational--reasons.

It turns out that many of the Americans defaulting on their mortgages are doing so out of anger, fear or despair rather than making a purely sensible decision about their best financial interests, a new study found. Though small--covering just 350 people--the study spotted a notable trend. Some of these people have stopped paying because they are anxious about their financial situation; others are furious that banks or the government won't help ease their load while other people are getting assistance. Hopelessness is a factor for others.

Brent White, an associate professor of law at the University of Arizona who ran the study, focused on "strategic defaults" in which a borrower who could afford to keep paying opted not to do so. That phenomenon is frequently described as a rational response by homeowners who are "underwater," owing far more than the current values of their homes.

But that isn't always the case. It depends on the cost of alternative housing and on future home-price movements, which are hard to predict. Also uncertain is how many years a borrower may need to repair a credit rating and whether the lender may try to collect any amount by which foreclosure-sale proceeds fall short of the loan balance.

Strategic defaults are becoming more common, various studies show--a Morgan Stanley report pegged them at 12% of all home-mortgage defaults in February, up from "insignificant levels" three years ago. Lenders fear borrowers who "walk away" will greatly increase the industry's foreclosure-related losses, which already total in the hundreds of billions of dollars.

Defaults are more likely to be strategic among people with higher credit scores and loan balances, Morgan Stanley found. That may be because people with higher credit scores typically have more money and thus can decide whether to pay rather than simply defaulting when they run out of cash.

Most people continue to pay their mortgages even when they are underwater, Mr. White noted, adding that "the stigma against default apparently remains robust." Many borrowers don't seem even to consider strategic defaults until they have "greatly depleted or exhausted" their savings, Mr. White said.

But Mr. White also sees a "contagion effect," in which people become more likely to default strategically if they know others who have done so. Loan-modification programs are supposed to provide hope but sometimes "actually fuel the hopelessness and anger" of borrowers, because these programs "seem designed to wear homeowners down," Mr. White said. Borrowers often can't get banks to respond to their questions and are repeatedly told to send in the same documents. In addition, lenders typically offer reduced payments only to homeowners who have defaulted or are considered likely to do so imminently. That angers people who have borrowed more conservatively and kept up on their payments but now "feel unfairly left out while the 'less deserving' get help," Mr. White said. To give more underwater homeowners an incentive to stay put, Mr. White suggests a "rent-based loan program" setting monthly payments in line with the cost of renting a comparable home. That would give borrowers a sense that they are paying a fair price for shelter, rather than "throwing their money away" on a home in which they may never have equity, he said.