Mortgage-servicing data do not contain information on current income or possible triggering life events, so previous research used out-of-date information, such as a household’s payment-to-income ratio at the time of mortgage origination, not when the payments stopped coming. Ganong and Noel looked into information on household financial circumstances at the time of default—defined as missing three mortgage payments—via the linked checking-account data.
To form a sort of baseline, they separated out defaulting homeowners with positive equity. Reasoning that these borrowers who were holding above-water mortgages couldn’t default because of negative equity, the researchers assumed they must be defaulting because of an adverse life event. They used income patterns as a benchmark for cash-flow defaults driven by negative life events, and sure enough, they find that for above-water homeowners, incomes declined sharply in the months leading up to a default.
They then find that underwater homeowners experienced similar income declines before defaulting. The drop in income leading up to default was almost identical for both groups, meaning that neither had enough cash available to cover a mortgage payment.
To separate out the double-trigger defaults, the researchers examined the impact of negative equity on default. They find that eliminating negative equity would prevent only 30 percent of defaults, leaving 70 percent of them entirely attributable to cash-flow issues. Twenty-four percent of defaults were a combination of the two. This held for homeowners with different levels of income and types of mortgages as well as across time periods and geography.
For policy makers, it matters why people default. Forgiveness of principal is costly and addresses only defaults related to negative equity. What could be more beneficial, according to the researchers, would be temporary payment reductions. Considering that the vast majority of defaults follow negative life events that could resolve themselves over a couple years, lowering payments temporarily could help banks recoup their money long term and help people keep their homes.