![]() ![]() ![]() Policymakers and lenders hoped that these modification policies would limit foreclosures and thereby prevent further downward spiral in home prices. Other programs provided principal reductions to reduce the borrowers’ debt obligations and thus increase the incentive for borrowers with negative equity to pay and remain in their homes. Some programs reduced interest rates or made other modifications to make monthly payments more affordable. Policymakers and lenders launched a variety of programs and loan modifications designed to help homeowners keep their homes. The default rate on all mortgages rose from about 2 percent in 2006 to over 11 percent by 2011, and the default rate on subprime mortgages rose from about 12 percent in 2006 to nearly 30 percent by 2011 (Federal Reserve Bank of Richmond 2012). The dramatic increase in residential mortgage default that occurred between 20 was one of the most important challenges confronting policymakers and economists during the financial crisis and Great Recession. These findings indicate that when borrowers suffer an income reduction, mortgage modification policies that reduce monthly payments to an affordable range are likely to be effective in preventing future defaults. Moreover, the analysis-which matches borrowers’ income, employment, and assets with their mortgage characteristics and payment status-shows that cash-strapped borrowers are more than seven times as likely to default as borrowers with strong ability to pay. New research finds that both motives were important during the Great Recession, but that ability to pay plays the greater role, accounting for over 60 percent of defaults. Is it because they’re truly unable to pay, or are they able to pay but have negative equity? To design mortgage modification policies that successfully stem default and allow borrowers to keep their homes, policymakers need to understand why borrowers default. The views expressed here are those of the authors, not necessarily those of others in the Federal Reserve System. The papers are an occasional series for a general audience. Economic Policy Papers are based on policy-oriented research produced by Minneapolis Fed staff and consultants. ![]()
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