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Financial Literacy, Social Perception and Strategic Default

Author

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  • Jeremy Burke
  • Kata Mihaly

Abstract

As a result of sustained housing market fragility, a growing number of borrowers are walking away from their underwater homes even though they have the ability to pay. Despite recent advances, questions remain about what influences this decision. In this paper, the authors use survey data to examine the role of social expectations, financial literacy and knowledge of default consequences. They find that homeowners who believe that others are likely to strategically default in the future are more willing to walk away as they anticipate reduced social stigma. Financially literate borrowers appear better able to calculate the benefits of strategically defaulting and are more willing to walk away at high levels of shortfall. They also find evidence that those who better understand the consequences of default, particularly that a default's impact on one's credit score weakens over time, have a higher willingness to walk away. Their results suggest that policies that help shape expectations about future strategic defaults may influence present foreclosures.

Suggested Citation

  • Jeremy Burke & Kata Mihaly, 2012. "Financial Literacy, Social Perception and Strategic Default," Working Papers WR-937, RAND Corporation.
    • Handle: RePEc:ran:wpaper:wr-937
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    References listed on IDEAS

    as
    1. Kristopher Gerardi & Adam Hale Shapiro & Paul S. Willen, 2007. "Subprime outcomes: risky mortgages, homeownership experiences, and foreclosures," Working Papers 07-15, Federal Reserve Bank of Boston.
    2. Charles Towe & Chad Lawley, 2013. "The Contagion Effect of Neighboring Foreclosures," American Economic Journal: Economic Policy, American Economic Association, vol. 5(2), pages 313-335, May.
    3. Andra C. Ghent & Marianna Kudlyak, 2010. "Recourse and residential mortgage default: theory and evidence from U.S. states," Working Paper 09-10, Federal Reserve Bank of Richmond.
    4. Foote, Christopher L. & Gerardi, Kristopher & Willen, Paul S., 2008. "Negative equity and foreclosure: Theory and evidence," Journal of Urban Economics, Elsevier, vol. 64(2), pages 234-245, September.
    5. Patrick Bajari & Chenghuan Sean Chu & Minjung Park, 2008. "An Empirical Model of Subprime Mortgage Default From 2000 to 2007," NBER Working Papers 14625, National Bureau of Economic Research, Inc.
    6. Michael J. Seiler & Vicky L. Seiler & Mark A. Lane & David M. Harrison, 2012. "Fear, Shame and Guilt: Economic and Behavioral Motivations for Strategic Default," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 40, pages 199-233, December.
    Full references (including those not matched with items on IDEAS)

    Citations

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    Cited by:

    1. Tran Huynh, 2023. "Financial Literacy and Mortgage Payment Delinquency?," Jena Economics Research Papers 2023-007, Friedrich-Schiller-University Jena.
    2. Kanis Saengchote & Krislert Samphantharak, 2020. "Delinquency Priority in Consumer Credit: Evidence from Thai Microdata," PIER Discussion Papers 135, Puey Ungphakorn Institute for Economic Research.
    3. Dimuthu Ratnadiwakara, 2021. "Collateral Value and Strategic Default: Evidence from Auto Loans," Journal of Financial Services Research, Springer;Western Finance Association, vol. 59(3), pages 209-240, June.
    4. Gregory Connor & Thomas Flavin, 2013. "Irish Mortgage Default Optionality," Economics Department Working Paper Series n243-13.pdf, Department of Economics, National University of Ireland - Maynooth.
    5. Saengchote, Kanis & Samphantharak, Krislert, 2022. "Banking relationship and default priority in consumer credit: Evidence from Thai microdata," Emerging Markets Review, Elsevier, vol. 52(C).
    6. Connor, Gregory & Flavin, Thomas, 2015. "Strategic, unaffordability and dual-trigger default in the Irish mortgage market," Journal of Housing Economics, Elsevier, vol. 28(C), pages 59-75.
    7. Bruhn, Miriam & Lara Ibarra, Gabriel & McKenzie, David, 2013. "Why is voluntary financial education so unpopular ? Experimental evidence from Mexico," Policy Research Working Paper Series 6439, The World Bank.

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