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Does Mandatory Loan Review Affect Mortgage Contract Choice and Performance?

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  • Itzhak Ben-David
  • Sumit Agarwal
  • Gene Amromin
  • Souphala Chomsisengphet
  • Douglas D. Evanoff

Abstract

We explore the effects of mandatory third-party review of mortgage contracts on the terms, availability, and performance of mortgage credit. Our study is based on a legislative pilot carried out by the State of Illinois in a selected set of zip codes in 2006. Mortgage applicants with low FICO scores were required to attend loan reviews by financial counselors. Applicants with higher FICO scores had to attend counseling only if they chose "risky mortgages." We find that low-FICO applicants for whom counselor review was mandatory did not materially change their contract choice. Conversely, applicants who could avoid counseling by choosing less risky mortgages did so. Although ex post default rates among low-FICO borrowers in the pilot program declined by 25%, we find that the educational component of counselor review played only a minor role. Instead, external review presented strong incentives for lenders to impose tighter ex ante screening on low-credit-quality borrowers.

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File URL: http://indstate.edu/business/NFI/leadership/papers/2011-WP-12_BenDavid.pdf
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Bibliographic Info

Paper provided by Indiana State University, Scott College of Business, Networks Financial Institute in its series NFI Working Papers with number 2011-WP-12.

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Length: 51 pages
Date of creation: May 2011
Date of revision:
Handle: RePEc:nfi:nfiwps:2011-wp-12

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Related research

Keywords: Financial counseling; screening; subprime crisis; household finance;

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References

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  1. Laibson, David, 1997. "Golden Eggs and Hyperbolic Discounting," The Quarterly Journal of Economics, MIT Press, vol. 112(2), pages 443-77, May.
  2. Xavier Gabaix & John C. Driscoll & David Laibson & Sumit Agarwal, 2008. "The Age of Reason: Financial Decisions Over the Lifecycle," 2008 Meeting Papers 322, Society for Economic Dynamics.
  3. Annamaria Lusardi & Peter Tufano, 2009. "Debt Literacy, Financial Experiences, and Overindebtedness," CeRP Working Papers 83, Center for Research on Pensions and Welfare Policies, Turin (Italy).
  4. Bernheim, B. Douglas & Garrett, Daniel M. & Maki, Dean M., 2001. "Education and saving:: The long-term effects of high school financial curriculum mandates," Journal of Public Economics, Elsevier, vol. 80(3), pages 435-465, June.
  5. Hirshleifer, David, 2007. "Psychological Bias as a Driver of Financial Regulation," MPRA Paper 5129, University Library of Munich, Germany.
  6. Benjamin J. Keys & Tanmoy Mukherjee & Amit Seru & Vikrant Vig, 2010. "Did Securitization Lead to Lax Screening? Evidence from Subprime Loans," The Quarterly Journal of Economics, MIT Press, vol. 125(1), pages 307-362, February.
  7. Bolton, Patrick & Freixas, Xavier & Shapiro, Joel, 2007. "Conflicts of interest, information provision, and competition in the financial services industry," Journal of Financial Economics, Elsevier, vol. 85(2), pages 297-330, August.
  8. Carlin, Bruce I., 2009. "Strategic price complexity in retail financial markets," Journal of Financial Economics, Elsevier, vol. 91(3), pages 278-287, March.
  9. Bucks, Brian & Pence, Karen, 2008. "Do borrowers know their mortgage terms?," Journal of Urban Economics, Elsevier, vol. 64(2), pages 218-233, September.
  10. Marianne Bertrand & Esther Duflo & Sendhil Mullainathan, 2002. "How Much Should We Trust Differences-in-Differences Estimates?," NBER Working Papers 8841, National Bureau of Economic Research, Inc.
  11. Annamaria Lusardi & Peter Tufano, 2009. "Debt Literacy, Financial Experiences, and Overindebtedness," NBER Working Papers 14808, National Bureau of Economic Research, Inc.
  12. Itzhak Ben-David, 2011. "Financial Constraints and Inflated Home Prices during the Real Estate Boom," American Economic Journal: Applied Economics, American Economic Association, vol. 3(3), pages 55-87, July.
  13. Lusardi, Annamaria & Tufano, Peter, 2009. "Debt literacy, financial experiences, and overindebtedness," CFS Working Paper Series 2009/08, Center for Financial Studies (CFS).
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