• KDI Journal of Economic Policy
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• v.40 no.3
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• pp.69-89
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• 2018

We study whether a default option attached to non-recourse mortgages improves borrowers' surplus from mortgage financing. By defaulting on mortgage debt, borrowers can save their non-collateralized income from being foreclosed. In exchange, borrowers must forgo non-monetary surplus from retaining any collateral. Banks may charge a high mortgage rate due to increased default rates. We find that the interest rate of non-recourse mortgage decreases with the borrower's surplus from home ownership. Moreover, non-recourse mortgages benefit only borrowers who deem housing property as an investment asset. Hence, the transition to a non-recourse mortgage is detrimental to welfare if the borrower enjoys a large surplus from home ownership. Although the borrower privately knows how much surplus she enjoys from home ownership, a menu of non-recourse mortgage contracts may exist, yielding a separating equilibrium without information rent.