Defaulting on debt is a pretty scary proposition. Whether it’s a credit card, student loans, or a mortgage, failing to pay comes with some serious consequences: damaged credit, inability to open new accounts, and even legal action. Because of this, people will generally do anything within their power to avoid default. But during the financial crisis, that wasn’t always the case.
As Americans watched their home values spiral downward, some made a choice to simply stop paying their mortgages, even when they were still technically able to make the payments. That choice is called strategic default and a recent study from researchers at the New York Federal Reserve suggests why some families utilized this option during the recession: For some, this was actually a smart financial decision, one that helped stave off other, potentially problematic credit problems.
The authors—Sewin Chan, Andrew Haughwout, Andrew Hayashi, and Wilbert van der Klaauw—looked at data and legal proceedings in order to figure out how households dealt with troubled mortgages from 2002 to 2011. They found that borrowers whose mortgages were the most forgiving were the most likely to default. For example, homeowners who were at least 10 percent underwater and who had borrowing terms that didn’t give lenders access to their other assets in the event of a default were 14 percent more likely to default.