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The impact of predatory loan terms on subprime foreclosures: The special case of prepayment penalties and balloon payments

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  • Roberto G. Quercia
  • Michael A. Stegman
  • Walter R. Davis

Abstract

There are growing concerns about the way predatory mortgages erode housing equity. We examine another potential impact: the relationship between abusive loan terms and foreclosure. Do predatory characteristics increase the likelihood of foreclosure once other risk factors are taken into account? We use a national database of subprime refinance first‐lien loans originated in 1999 to analyze this question. Even after we control for other factors, refinance loans with prepayment penalties are 20 percent more likely and those with balloon payments are 50 percent more likely to experience a foreclosure than other loans. These findings suggest that predatory loans have the potential not only to erode household wealth, but also to heighten negative effects on individuals, households, and communities. Excluding losses to borrowers, we estimate that prepayment penalties and balloon payment requirements in 1999 refinance originations increased national foreclosure‐related losses to lenders and investors by about $465 and $127 million, respectively.

Suggested Citation

  • Roberto G. Quercia & Michael A. Stegman & Walter R. Davis, 2007. "The impact of predatory loan terms on subprime foreclosures: The special case of prepayment penalties and balloon payments," Housing Policy Debate, Taylor & Francis Journals, vol. 18(2), pages 311-346, January.
    • Handle: RePEc:taf:houspd:v:18:y:2007:i:2:p:311-346
    DOI: 10.1080/10511482.2007.9521603
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    References listed on IDEAS

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    1. Amy Cutts & Robert Order, 2004. "On the Economics of Subprime Lending," The Journal of Real Estate Finance and Economics, Springer, vol. 30(2), pages 167-196, November.
    2. Michelle A. Danis & Anthony Pennington-Cross, 2005. "A dynamic look at subprime loan performance," Working Papers 2005-029, Federal Reserve Bank of St. Louis.
    3. Souphala Chomsisengphet & Anthony Pennington-Cross, 2006. "Subprime refinancing: equity extraction and mortgage termination," Working Papers 2006-023, Federal Reserve Bank of St. Louis.
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    Cited by:

    1. Morgan J. Rose, 2011. "Prepayment Penalties: Efficieny and Predation," UMBC Economics Department Working Papers 11-133, UMBC Department of Economics.
    2. An, Xudong & Deng, Yongheng & Gabriel, Stuart A., 2011. "Asymmetric information, adverse selection, and the pricing of CMBS," Journal of Financial Economics, Elsevier, vol. 100(2), pages 304-325, May.
    3. O. Emre Ergungor & Stephanie Moulton, 2014. "Beyond the Transaction: Banks and Mortgage Default of Low‐Income Homebuyers," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 46(8), pages 1721-1752, December.
    4. Tahsin, Salman, 2022. "Home price growth and minority access to mortgage credit," Journal of Economics and Business, Elsevier, vol. 120(C).
    5. Lozinskaia Agata & Ozhegov Evgeniy, 2016. "Key Determinants of Demand, Credit Underwriting, and Performance on Government-Insured Mortgage Loans in Russia," EERC Working Paper Series 16/03e, EERC Research Network, Russia and CIS.
    6. Xu, Yilan, 2014. "Does mortgage deregulation increase foreclosures? Evidence from Cleveland," Regional Science and Urban Economics, Elsevier, vol. 46(C), pages 126-139.
    7. John Gilderbloom & Katrina Anaker & Gregory Squires & Matt Hanka & Joshua Ambrosius, 2011. "Why Foreclosure Rates in African American Neighborhoods are so High: Looking at the Real Reaonss," ERSA conference papers ersa11p1597, European Regional Science Association.
    8. Chunhui Ren, 2020. "A Framework for Explaining Black-White Inequality in Homeownership Sustainability," Demography, Springer;Population Association of America (PAA), vol. 57(4), pages 1297-1321, August.

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