Working Paper: NBER ID: w16586
Authors: Christopher J. Mayer; Tomasz Piskorski; Alexei Tchistyi
Abstract: This paper explores the practice of mortgage refinancing in a dynamic competitive lending model with risky borrowers and costly default. We show that prepayment penalties improve welfare by ensuring longer-term lending contracts, which prevents the mortgage pools from becoming disproportionately composed of the riskiest borrowers over time. Mortgages with prepayment penalties allow lenders to lower mortgage rates and extend credit to the least creditworthy, with the largest benefits going to the riskiest borrowers, who have the most incentive to refinance in response to positive credit shocks. Empirical evidence from more than 21,000 non-agency securitized fixed rate mortgages is consistent with the key predictions of our model. Our results suggest that regulations banning refinancing penalties might have the unintended consequence of restricting access to credit and raising rates for the least creditworthy borrowers.
Keywords: No keywords provided
JEL Codes: D12; D14; D53; G14; G21; G28; R31; R38
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| prepayment penalties (G51) | longer-term lending contracts (G21) |
| longer-term lending contracts (G21) | mortgage pools composition (G21) |
| prepayment penalties (G51) | mortgage rates (G21) |
| mortgage rates (G21) | borrower credit access (G51) |
| lower mortgage rates (G21) | riskiest borrowers refinancing (G51) |
| prepayment penalties (G51) | borrower welfare (G51) |