- Share
Is There a Puzzle in Underwater Mortgage Default?
A recurring question in the mortgage default literature is why underwater default is rare relative to model predictions. We find that one answer is miscalibration of flow payoffs. We build a novel, detailed quantitative model of mortgage default and find that realistic rent dynamics plus mild levels of default costs are sufficient to eliminate negative-equity strategic default. We present further empirical results supporting our model's focus on flow payoffs. Our model addresses the underwater mortgage default puzzle, offers more realistic interpretations of policy consequences, and reinforces the theoretical effectiveness of cash-flow-based interventions.
Working Papers of the Federal Reserve Bank of Cleveland are preliminary materials circulated to stimulate discussion and critical comment on research in progress. They may not have been subject to the formal editorial review accorded official Federal Reserve Bank of Cleveland publications. The views expressed in this paper are those of the authors and do not represent the views of the Federal Reserve Bank of Cleveland or the Federal Reserve System.
Suggested Citation
Loewenstein, Lara, Paul S. Willen, Yuxi Yao, and David Zhang. 2025. “Is There a Puzzle in Underwater Mortgage Default?” Federal Reserve Bank of Cleveland, Working Paper No. 25-22. https://doi.org/10.26509/frbc-wp-202522
This work by Federal Reserve Bank of Cleveland is licensed under Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 International
