RT Journal Article SR Electronic T1 Strategic Defaults on First and Second Lien Mortgages
during the Financial Crisis JF The Journal of Fixed Income FD Institutional Investor Journals SP 7 OP 23 DO 10.3905/jfi.2011.20.4.007 VO 20 IS 4 A1 Julapa Jagtiani A1 William W. Lang YR 2011 UL https://pm-research.com/content/20/4/7.abstract AB Strategic default behavior suggests that the default process is not only a matter of the inability to pay. Economic costs and benefits affect the incidence and timing of defaults. As with prior research, this article finds that people default strategically as their home value falls below the mortgage value (exercise the put option to default on their first mortgage). While some of these homeowners default on both first mortgages and second lien home equity lines, a large portion of the delinquent borrowers have kept their second lien current during the recent financial crisis. These second liens, which are current but stand behind a seriously delinquent first mortgage, are subject to a high risk of default. However, relatively few borrowers default on their second liens while remaining current on their first. This article explores the strategic factors that may affect borrower decisions to default on first vs. second lien mortgages. This study finds that borrowers are more likely to remain current on their second lien if it is a home equity line of credit (HELOC) rather than a closed-end home equity loan. Moreover, the size of the unused line of credit is an important factor. Interestingly, we find evidence that the various mortgage loss mitigation programs also play a role in providing incentives for homeowners to default on their first mortgages.TOPICS: MBS and residential mortgage loans, financial crises and financial market history, credit risk management