Is There a Puzzle in Underwater Mortgage Default?

RePEc Short ID: plo411
ORCID iD: 0000-0002-7203-6470

Loewenstein, Lara; Willen, Paul S.; Yao, Yuxi; Zhang, David Hao

doi:10.29412/res.wp.2025.08

Working Paper

Is There a Puzzle in Underwater Mortgage Default?

Abstract: 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.

JEL Classification: D15; G51; R30;

https://doi.org/10.29412/res.wp.2025.08