The Effect of Perceived Lender Characteristics and Market Conditions on Strategic Mortgage Defaults

Inequity Aversion has long been applied in a game theoretic setting to explain that individuals are willing to sacrifice personal wealth in order to financially penalize players they perceive to be acting selfishly or unfairly. I apply inequity aversion to strategic mortgage default decisions and find that individual homeowners (as well as a second sample of professional mortgage lenders) have a differential stated willingness to walk away from their mortgage based on the perceived characteristics of their lender. Importantly, these significant differences can be removed even with extremely modest loan modifications. Finally, I document that regular homeowners and even professional lenders do a poor job differentiating between the owner of their loan and the servicer of their loan. This is particularly troubling given the extreme misconception of their bank’s true character. As a result, much of their willingness to penalize is misplaced resulting in an unnecessary number of strategic mortgage defaults.