Why borrowers refuse to use their home as collateral


American households have most of their wealth in retirement savings (33%) and home equity (29%). Of that amount, home equity has exceeded $ 25 trillion, according to the latest data from the Federal Reserve. It’s no surprise that homeowners with mortgage debt are reluctant to give up their homes in the event of foreclosure and may defy financial logic to avoid defaulting on their loans.

Recent research on mortgage defaults shows that home loan borrowers often continue to make mortgage payments even when they are seriously underwater, when the loan amount exceeds the value of their home. “Homeowners place great importance on staying in their home, sometimes at a high cost to them by continuing to make mortgage payments, spending a lot of money after the bad,” says Benjamin Keys, professor of real estate. in Wharton. In addition to the financial cost of default, borrowers also face “a moral component” in terms of the stigma attached to default and moving expenses, he explains.

Understandably, homeowners are reluctant to post their homes as collateral. For the first time, a research paper titled “The Cost of Consumer Collateral: Evidence from Bunching” written by experts from Wharton and elsewhere captured the degree of this aversion among homeowners to post their homes as collateral. Keys co-authored the article with Benjamin L. Collier and Cameron Ellis, both professors of risk management, insurance, and healthcare at the Fox School of Business at Temple University; Collier is also a researcher at Wharton.

This degree of “collateral aversion” cannot be determined from mortgage debt data, because most home loans require some form of collateral, Keys notes.

Researchers overcame this hurdle by finding a useful indicator in data from the Federal Disaster Lending Program, which provides subsidized loans to households that have suffered a natural disaster (e.g., hurricane, tornado, fire in forest) to repair the damage caused to their main residence and the replacement of destroyed goods. Under the program, those who borrow more than $ 25,000 must indicate their primary residence as collateral.

Analysis of data from the federal disaster loan program shows “how much borrowers hate providing collateral,” Keys notes. Research found that 30% of all borrowers “pooled” at the unsecured threshold of $ 25,000; loans larger than that required them to put their house as collateral.

The analysis estimates the median degree of aversion to collateral at 40%: when the threshold is $ 25,000, half of the borrowers who could borrow $ 40,000 only borrowed $ 25,000, giving up $ 15,000 in credit. enhanced. “Even homeowners who are currently underwater – and would not lose any equity if they defaulted – typically band together at the unsecured threshold,” Keys explains. “The financial costs of default and the moral costs of default are the same regardless of the use of collateral, so the only thing that varies at the threshold is fear of being evicted from their home. “

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