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Do financial counseling mandates improve mortgage choice and performance? Evidence from a legislative experiment

Author

Listed:
  • Sumit Agarwal
  • Eugene Amromin
  • Itzhak Ben-David
  • 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 experiment in which the State of Illinois required “high-risk” mortgage applicants acquiring or refinancing properties in 10 specific zip codes to submit loan offers from state-licensed lenders to review by HUD-certified financial counselors. We document that the legislation led to declines in both the supply of and demand for credit in the treated areas. Controlling for the salient characteristics of the remaining borrowers and lenders, we find that the ex post default rates among counseled low-FICO-score borrowers were about 4.5 percentage points lower than those among similar borrowers in the control group. We attribute this result to actions of lenders responding to the presence of external review and, to a lesser extent, to counseled borrowers renegotiating their loan terms. We also find that the legislation pushed some borrowers to choose less risky loan products in order to avoid counseling.

Suggested Citation

  • Sumit Agarwal & Eugene Amromin & Itzhak Ben-David & Souphala Chomsisengphet & Douglas D. Evanoff, 2009. "Do financial counseling mandates improve mortgage choice and performance? Evidence from a legislative experiment," Working Paper Series WP-09-07, Federal Reserve Bank of Chicago.
  • Handle: RePEc:fip:fedhwp:wp-09-07
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    Cited by:

    1. Margaret Miller & Julia Reichelstein & Christian Salas & Bilal Zia, 2015. "Can You Help Someone Become Financially Capable? A Meta-Analysis of the Literature," World Bank Research Observer, World Bank Group, vol. 30(2), pages 220-246.
    2. Almenberg, Johan & Karapetyan, Artashes, 2009. "Mental Accounting in the Housing Market," SSE/EFI Working Paper Series in Economics and Finance 718, Stockholm School of Economics, revised 28 Aug 2010.
    3. Carpena, Fenella & Cole, Shawn & Shapiro, Jeremy & Zia, Bilal, 2011. "Unpacking the causal chain of financial literacy," Policy Research Working Paper Series 5798, The World Bank.
    4. Johan Almenberg & Artashes Karapetyan, 2012. "The hidden costs of hidden debt," Working Paper 2011/22, Norges Bank.
    5. Danielle Winchester & Sandra Huston, 2013. "Keeping Your Financial Planner to Yourself: Racial and Cultural Differences in Financial Planner Referrals," The Review of Black Political Economy, Springer;National Economic Association, vol. 40(2), pages 165-184, June.
    6. Kosfeld, Michael & Schüwer, Ulrich, 2011. "Add-on Pricing, Naive Consumers, and the Hidden Welfare Costs of Education," CEPR Discussion Papers 8636, C.E.P.R. Discussion Papers.
    7. Sumit Agarwal & John C. Driscoll & Xavier Gabaix & David Laibson, 2009. "The Age of Reason: Financial Decisions over the Life Cycle and Implications for Regulation," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 40(2 (Fall)), pages 51-117.
    8. Xu, Yilan, 2014. "Does mortgage deregulation increase foreclosures? Evidence from Cleveland," Regional Science and Urban Economics, Elsevier, vol. 46(C), pages 126-139.

    More about this item

    Keywords

    Financial literacy ; Mortgage loans ; Households - Finance;

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