Insolvency, Trigger Events, and Consumer Risk Posture in the Theory of Single-family Mortgage Default*

This paper integrates notions of insolvency, trigger events, and consumer risk posture into the theory of single-family mortgage default. It presents a traditional consumeror choice-theoretic framework that recognizes common elements of mortgage optionality alongside insolvency, income, house price, and interest rate variables. Two motivations for mortgage default, insolvency and exercise of a strategic option, are identified and compared under alternative settings. The model suggests that insolvency is a primary motivation for default. Broader measures of consumer financial health appear to provide better measures of the likelihood of default than do narrow measures based solely on home or mortgage value. Adverse shocks to income and house prices, but not interest rates, also affect default and insolvency through the erosion of personal wealth. Empirical evidence supporting the hypotheses developed is provided along with an analysis of the aggregate time series of mortgage default. *The authors would like to thank David Ling for helpful comments. The views expressed are those of the authors and not necessarily those of the Federal Deposit Insurance Corporation.