New Study by ODU’s Seiler Points to Likely Increase in Strategic Mortgage Defaults Unless Lenders Take Action
February 07, 2013
An explosive new study from renowned Old Dominion University researcher Michael Seiler suggests that a wave of strategic defaults - homeowners walking away from mortgages they can afford to pay - could occur nationwide if the public comes to realize how minuscule the possibility is that financial backlash awaits them.
Seiler's new study, "The Role of Informational Uncertainty in the Decision to Strategically Default," identifies a severe gap between the sanctions homeowners believe they'll receive and the reality that lenders rarely pursue deficiency judgments against those who strategically default.
The Robert M. Stanton Chair of Real Estate in ODU's College of Business and Public Administration, and the founding director of the Institute for Behavioral and Experimental Real Estate (www.IBERE.org), Seiler said maintaining that uncertainty about what awaits mortgage defaulters is one of the only things stopping homeowners from walking away from their mortgages en masse, as the societal stigma against doing so declines.
"What is holding them back from defaulting is a staunch belief that the lender will pursue the resulting deficiency judgment," Seiler said.
Currently, reports suggest that between 17 percent and 26 percent of mortgage defaults are so-called strategic defaults. Those defaults emanate almost exclusively from mortgages written before the housing market crash of 2007, because the financial crisis that followed led to stricter standards for mortgage lending.
Seiler's study of 1,845 homeowners across the United States found that, on average, homeowners believe it's about 70 percent likely that their lender will pursue them for the deficiency amount if their home is foreclosed on. In fact, interviews with mortgage authorities suggest that seeking financial redress from homeowners following foreclosure occurs less than 10 percent of the time.
"This best-kept industry secret is ostensibly predominantly responsible for the fear that is preventing countless would-be strategic defaulters from pursuing this course of action," Seiler said.
Seiler's study actually recommends to mortgage lenders and policymakers that it's more prudent to remain silent or give only generic information as it relates to liquidating damages and specific courses of action in the event of a strategic default, along with continuing to encourage and promote the immorality of the actions of perpetrators of strategic default.
Based on the Theory of Incomplete Contracts, it can actually benefit a lender or policymaker to use informational uncertainty, or strategically omit recourse actions that would follow a breach of a legal contract, Seiler said.
But as word about strategic mortgage default spreads, and the stigma surrounds it vanishes, Seiler argues that mortgage lenders may need to step up their campaign against the practice. "Lenders and policymakers who wish to prevent strategic defaults from gaining in communality should heavily promote or even extend the belief that strategic defaulters will be pursued by lenders," he said. "This can be done through various campaigns, heavy media coverage of select high-profile cases or lenders actually pursuing deficiency judgments."
Since arriving at ODU in 2008 from Hawaii Pacific University, Seiler has published a number of groundbreaking studies incorporating the human element in real estate decisions, especially in the area of strategic default.
In the Institute for Behavioral and Experimental Real Estate (IBERE), which Seiler founded in 2011, traditional economic models to understand real estate are adapted to incorporate the element of human decision-making, including the mental shortcuts taken on a subconscious level that sometimes result in flaws or biases.
IBERE's goal is to find and measure these flaws and, where possible, suggest ways to correct them. The institute seeks to be the leading behavioral and experimental real estate research organization in the world and to publish research that will help guide decision-making in all areas of real estate - for homeowners, the real estate industry, investors and public policymakers.