URI Marketing Professor Stephen Atlas’ research sheds light on financial decision-making for one of the largest purchases that most consumers make in their lifetime — a home.

It is well known that mortgages have important welfare implications for consumers and yet, as we have seen, collectively some mortgage lending practices have had disastrous consequences for the global economy. There is comparatively little research on why people choose different mortgages, despite the fact that these differences are otherwise interesting to marketers and drive the collective risk exposure for the mortgage industry.

The Journal of Marketing Research will soon publish research by College of Business Administration Assistant Professor of Marketing Stephen Atlas that sheds light on financial decision-making for one of the largest purchases that most consumers make in their lifetime — a home. Atlas’ research paper provides a useful approach to study how consumers make decisions across time, involving tradeoffs between immediate and future consequences.

Industry Context

The 2008 financial crisis began with the collapse of the mortgage industry, which was previously believed to be built on a solid foundation. Prior to that, new forms of mortgages (such as 2-28 loans and balloon-payment loans) made it easier for people with bad credit to obtain financing, as they could afford the “teaser” low monthly payments in the short run, improve their credit, and refinance before the larger monthly payments set in. Meanwhile, the rise of home prices fueled the economy – by some estimates, homeowners were spending 30 cents of every dollar towards their living expenses as they refinanced their homes to delay repayment.

The collapse of the mortgage industry showed how there was no way that homeowners could possibly repay the loans they had been empowered to choose, and as the house of cards collapsed, the consequences reverberated across the financial sector and led to a collapse of the housing market and global economy. Many effects of this are still felt today. Locally, as of June 2016, 13% of Rhode Island mortgages have negative home equity – the mortgages are larger than the value of the underlying property, a situation also known as being “underwater.” The paper cites sources indicating that mortgages represent the majority of US consumer debt ($10.5 out of $14 billion in 2009). How consumers choose and manage their mortgage debt has important implications nationally and globally.

Decision-Making Parameters

In the paper, Atlas presents a useful framework for how consumers make decisions with consequences across time by considering two properties of impatience. The first is that people tend to place a greater importance on sooner events to later events.  For example, many consumers would rather receive $100 in 5 years than in $150 in 10 years, in a principle known as long-term discounting. The second is that we place a special importance on immediate consequences, a principle known as present bias.

Long-term discounting and present bias have different properties. For example, many people would rather receive $100 today instead of $150 in one year, but also $150 in two years instead of $100 in one year, so adding one year of time to each alternative will reverse that choice. This is due to present bias, since long-term discounting is consistent across time.

Atlas’ forthcoming paper considers how individual differences in these two types of time preferences relate to mortgage choices. While both long-term discounting and present bias encourage selecting mortgages with delayed repayment schedules, they have different effects on whether homeowners maintain or abandon an “underwater” mortgage.

Key Study Findings

The paper finds that both types of time preferences – long-term discounting and present bias — are linked with choosing back-loaded mortgage repayment schedules which delay repayment into the future rather than a larger payment today.

Additionally, in situations involving negative home equity, the study finds that long-term discounting is related with defaulting on the mortgage, while present bias is related with maintaining the mortgage. One implication of this is that homeowners with present bias face a financial “double-whammy,” selecting back loaded mortgages and then continuing to pay them despite financial incentives to default. This result affirms that present bias is a useful addition to how we think about time preferences among consumers.

This paper was a collaboration with Eric Johnson at Columbia University and John Payne at Duke University. Their model used field data from a national survey of mortgaged households, augmented by zip-code level house price and foreclosure data. Atlas’ work specializes in consumer financial decisions and mental accounting in consumer choice, and has also been featured in Advances in Consumer Research, The Journal of Virtual World Research and the Southern Economic Journal.

About Stephen Atlas

Atlas earned his Ph.D. in Business from Columbia University. His dissertation was selected as winner of the 2013 Doctoral Dissertation Competition in Behavioral Pricing by the Pricing Center at Fordham University and was a finalist in the Mary Kay Doctoral Dissertation Competition awarded by the Academy of Marketing Science. He also received a B.A. in economics from Brown University and a M.A. in economics from Tufts University, where he examined how social norms influence online financial choices. Previously, he worked as a consultant with Deloitte. At URI, Atlas teaches marketing research and customer analytics. View profile.

About the Journal of Marketing Research

Journal of Marketing Research concentrates on the subject of marketing research, from its philosophy, concepts, and theories to its methods, techniques, and applications. This bimonthly, peer-reviewed journal is published for technically oriented research analysts, educators, and statisticians. View website.