Time Preferences, Mortgage Choice, and Strategic Default
Coauthor(s): Johnson, Eric J., Stephen A. Atlas and John W. Payne
Nearly 30% of American homes have mortgage debt that exceeds the current market value of the home, a situation known colloquially as being “underwater.” This paper investigates whether individual differences in time preferences, particularly a “present bias” (a tendency to overvalue immediate outcomes), affect both the choices that lead to underwater mortgages and the consumers’ responses to being underwater. Using market data from commercial sources and a survey of 244 mortgaged households, we relate two components of individual time preference, a present bias and the discount rate for outcomes beyond the present, to mortgage choices. Underwater homeowners exhibit both more present bias and a greater rate of discounting. Consumers with a greater present bias also were more likely to have an adjustable-rate mortgage and to have a second mortgage on the home. We also examine the willingness of people to abandon this mortgage, known colloquially as walking away. Here greater present bias decreases the likelihood that consumers will walk away from an underwater mortgage, whereas higher discounting increases the likelihood that consumers will walk away. Time preferences remain robust predictors in the presence of market-level controls and model specifications. We close by discussing the role of time preferences in consumer financial decisions.
Johnson, Eric J., Stephen A. Atlas and John W. Payne "Time Preferences, Mortgage Choice, and Strategic Default ." , Columbia Business School, (2011).