State Foreclosure Laws and the Incidence of Mortgage Default

Posted: 2 May 2011 Last revised: 10 Jul 2014

Cem Demiroglu

Koc University, College of Administrative Sciences and Economics

Evan Dudley

Queen's University

Christopher M. James

University of Florida - Department of Finance, Insurance and Real Estate

Date Written: October 7, 2013

Abstract

This paper examines how differences in state foreclosure laws influence the incidence of default in the residential mortgage market. Specifically, we examine how judicial review requirements, lenders’ recourse rights (deficiency judgments), and state assistance programs for distressed borrowers affect the likelihood of default during the recent US housing crisis. We argue that state foreclosure laws should have little effect on the likelihood of liquidity events (for example, shocks to borrowers' ability to make payments) and thus provide a good instrument for identifying the borrower’s costs of default. We find that borrowers with negative home equity are significantly more likely to default in states with borrower-friendly foreclosure laws. Moreover, we find that foreclosure laws that are positively correlated with default are also negatively correlated with personal bankruptcy, which supports the view that foreclosure laws are instruments for costs of default and not merely proxies for unobserved income shocks. Finally, we examine how recent state and federal loan foreclosure prevention programs have affected the likelihood of default. Overall, we find a significant decline in the effect of judicial review requirements but not deficiency judgments on default after 2008.

Keywords: Strategic Default, Mortgage Crisis, Foreclosure Process, State Foreclosure Laws

JEL Classification: G1, G21, K35

Suggested Citation

Demiroglu, Cem and Dudley, Evan and James, Christopher M., State Foreclosure Laws and the Incidence of Mortgage Default (October 7, 2013). Journal of Law and Economics Vol. 57, 2014, pp.225-280. Available at SSRN: https://ssrn.com/abstract=1829346 or http://dx.doi.org/10.2139/ssrn.1829346

Cem Demiroglu

Koc University, College of Administrative Sciences and Economics ( email )

Koc University
Sariyer
Istanbul, 34450
Turkey
90-212-338-1620 (Phone)
90-212-338-1653 (Fax)

HOME PAGE: http://https://sites.google.com/site/cemdemiroglu/

Evan Dudley

Queen's University ( email )

Smith School of Business
Goodes Hall, Rm 438
Kingston, Ontario K7L 3N6
Canada

Christopher M. James (Contact Author)

University of Florida - Department of Finance, Insurance and Real Estate ( email )

P.O. Box 117168
Gainesville, FL 32611-7168
United States
352-392-3486 (Phone)
352-392-0301 (Fax)

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