Foreclosure Contagion and the Neighborhood Spillover Effects of Mortgage Defaults

Abstract

I identify shocks to interest rates resulting from two administrative details in adjustable-rate mortgage contract terms: the choices of financial index and lookback period. I find that a 1 percentage point increase in interest rates at the time of ARM reset results in a 2.5 percentage rise in the probability of foreclosure in the following year; and that each foreclosure filing leads to an additional 0.3-0.6 completed foreclosures within a 0.10 mi radius. I emphasize price effects, bank-supply responses, and borrower responses arising from peer effects in explaining this result.

Keywords: foreclosure, contagion, social effects

JEL Classification: G21, R30, G33