What Will It Take to ‘Fix’ Strategic Default? Wharton’s Alex Edmans Points to the Power of Incentives to Influence At-Risk Homeowners Concerned about Negative Equity

RUMSON, N.J.--()--As an increasing number of homeowners in the U.S. are strategically defaulting on their mortgages, Wharton finance professor Alex Edmans argues that the alignment of incentives is the critical missing link in most government and banking industry programs to stop homeowners from walking away from their homes even when they may be able to continue paying their mortgage.

Edmans lays out his argument in Knowledge@Wharton.com, the online business journal of the Wharton School of the University of Pennsylvania, in an article entitled “Home Is Where the Money Is: A New Incentive Program Aims to Slow Rising Mortgage Defaults. His idea involves an incentive program called Responsible Homeowner Reward (RH Reward), which offers borrowers a substantial cash incentive only if they fully satisfy their mortgage obligation. The article stems from Edmans’ recent white paper titled "The Responsible Homeowner Reward: An Incentive-Based Solution to Strategic Mortgage Default," where he suggests that the program could help both homeowners and the financial institutions who own their mortgages to avoid the painful and costly process of a default and foreclosure. Moreover, it could benefit the entire housing market by stabilizing prices and preventing homes from being abandoned, which can affect the value of entire neighborhoods.

Edmans points to a chain reaction of catalysts: The decline in housing creates negative equity, homeowners react to negative equity, and lenders and society at large, including our communities, are negatively impacted. He adds, “Now, default is a conscious choice. It's discretionary. We used to think it was automatic – either you had the money or you didn't. But when the default becomes discretionary, the idea of incentives becomes relevant."

Edmans’ paper discusses the structure of the RH Reward Program, which is different from other mortgage default solutions because its benefit is only realized by the homeowner after the mortgage obligation is fulfilled. In other programs, a bank may make concessions, only to have a homeowner wind up in default later, leaving the financial institution with a reduced claim. According to Edmans, the simplicity of the RH Reward concept is one of its key strengths. "The rules of RH Reward are unambiguous, and so the homeowner knows what he needs to do to receive the RH Reward – repay or refinance the loan."

Frank Pallotta, Managing Partner of Loan Value Group, the exclusive provider of the RH Reward program, says, “With nearly 25% of all outstanding mortgages now underwater, strategic default is a real and growing concern. Unless something is done to address the problem, mortgage servicers will face a wave of borrowers who may consider walking away as the most logical response to negative equity.” Pallotta adds, “The typical homeowner buys a home for two reasons: investment, and shelter. However, when their equity disappears, and affordable shelter is plentiful, strategic default becomes a viable option. For a bank to replace a small portion of the borrower’s negative equity at a cost that is a fraction of the overall cost of default seems logical.”

Professor Edmans is an academic advisor to Loan Value Group LLC.

About Loan Value Group LLC

Loan Value Group LLC, based in Rumson, NJ, is a solutions provider to owners of risk that directly addresses strategic default. LVG’s incentive-based solutions allow mortgage owners and servicers to positively influence consumers by rewarding timely mortgage payments. Loan Value Group is the exclusive provider of the Responsible Homeowner Reward ("RH Reward"). Institutions can learn more by contacting Frank Pallotta or visiting Loan Value Group. Consumers can learn more by visiting RHReward.com.

Contacts

Media:
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Rosalia Scampoli, 212-537-5177, Ext 7
rscampoli@marketcompr.com

Release Summary

Wharton professor points to incentives as missing link in strategic default initiatives

Contacts

Media:
Marketcom PR
Rosalia Scampoli, 212-537-5177, Ext 7
rscampoli@marketcompr.com