Kristopher S. Gerardi, Kyle Herkenhoff, Lee Ohanian, Paul S. Willen, 10 January 2017

Many studies have addressed the question of why people default on their mortgages, but lack of data has meant that much of this research has omitted the effect of the owner's ability to pay. This column uses panel data on defaults and changes in income to show that ability to pay is a much more important determinant of default than previously recognised. If the head of household loses a job, for example, this is equivalent to the effect of a 35% drop in home equity. Policies targeted at increasing ability to pay may be more effective at reducing default than those that try to remedy negative equity.