Psychic Moving Costs and Mortgage Default with Positive Equity

Many struggling mortgage borrowers who have home equity lose it through foreclosure. To explainwhy they do not just sell their homes instead, this paper develops a new model of mortgage default in which homeowners face psychic moving costs. A transparent calibration procedure yields psychic moving costs that are empirically accurate, heterogeneous, and large. The model explains abovewater default: after a liquidity shock, abovewater homeowners often default rather than sell in an ex-ante optimal gamble to avoid moving. Psychic moving costs also mostly explain why underwater borrowers so rarely walk away from their homes, another major puzzle in the literature. Relative to a nested model without abovewater default, the full model produces starkly different results in policy experiments. Wealth maximization motivates many fewer defaults, so suing defaulters prevents less than one-fifth as many foreclosures after a drop in house prices. But liquidity constraints alone drive many more defaults, so forbearance prevents between three and seven times more foreclosures after a drop in aggregate income