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Prepayment Penalties: Efficieny and Predation

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    Abstract

    This paper presents evidence that reductions in mortgage interest rates associated with prepayment penalties are greater for riskier borrowers, as measured by mortgage type, credit scores, and local incomes and education levels. This is consistent with an efficiency view that, by reducing the reclassification risk faced by lenders, prepayment penalties can be welfare-improving. Additional findings indicate that prepayment penalties are also used as a predatory lending tool, but that the efficiency view dominates the predatory view in most circumstances. State anti-predatory lending laws restricting the duration and amount of prepayment penalties appear to curb the predatory use of prepayment penalties.

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    File URL: http://www.umbc.edu/economics/wpapers/wp_11_133.pdf
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    Bibliographic Info

    Paper provided by UMBC Department of Economics in its series UMBC Economics Department Working Papers with number 11-133.

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    Length: 39 pages
    Date of creation: 01 Oct 2011
    Date of revision:
    Handle: RePEc:umb:econwp:11133

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    Phone: 410-455-2160
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    Web page: http://www.umbc.edu/economics
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    Keywords: prepayment penalties; predatory lending; financial regulation; mortgage crisis; reclassification risk;

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    1. Robert B. Avery & Glenn B. Canner & Robert E. Cook, 2005. "New information reported under HMDA and its application in fair lending enforcement," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Sum, pages 344-394.
    2. Igal Hendel & Alessandro Lizzeri, 2003. "The Role Of Commitment In Dynamic Contracts: Evidence From Life Insurance," The Quarterly Journal of Economics, MIT Press, vol. 118(1), pages 299-327, February.
    3. Yuliya Demyanyk & Otto Van Hemert, 2011. "Understanding the Subprime Mortgage Crisis," Review of Financial Studies, Society for Financial Studies, vol. 24(6), pages 1848-1880.
    4. Michelle A. Danis & Anthony Pennington-Cross, 2005. "The delinquency of subprime mortgages," Working Papers 2005-022, Federal Reserve Bank of St. Louis.
    5. Anthony Pennington-Cross & Giang Ho, 2010. "The Termination of Subprime Hybrid and Fixed-Rate Mortgages," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 38(3), pages 399-426.
    6. Christopher J. Mayer & Tomasz Piskorski & Alexei Tchistyi, 2010. "The Inefficiency of Refinancing: Why Prepayment Penalties Are Good for Risky Borrowers," NBER Working Papers 16586, National Bureau of Economic Research, Inc.
    7. Antje Berndt & Burton Hollifield & Patrik Sandås, 2010. "The Role of Mortgage Brokers in the Subprime Crisis," NBER Chapters, in: Market Institutions and Financial Market Risk National Bureau of Economic Research, Inc.
    8. Rose, Morgan J., 2008. "Predatory lending practices and subprime foreclosures: Distinguishing impacts by loan category," Journal of Economics and Business, Elsevier, vol. 60(1-2), pages 13-32.
    9. Elliehausen, Gregory & Staten, Michael E. & Steinbuks, Jevgenijs, 2008. "The effect of prepayment penalties on the pricing of subprime mortgages," Journal of Economics and Business, Elsevier, vol. 60(1-2), pages 33-46.
    10. Susan E. Woodward & Robert E. Hall, 2010. "Consumer Confusion in the Mortgage Market: Evidence of Less Than a Perfectly Transparent and Competitive Market," American Economic Review, American Economic Association, vol. 100(2), pages 511-15, May.
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