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The Inefficiency of Refinancing : Why Prepayment Penalties Are Good for Risky Borrowers

Author: Christopher J Mayer; Tomasz Piskorski; Alexei Tchistyi
Publisher: Cambridge, Mass. National Bureau of Economic Research 2010.
Series: Working paper series (National Bureau of Economic Research), no. w16586.
Edition/Format:   eBook : Document : EnglishView all editions and formats
Summary:
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  Read more...
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Details

Material Type: Document, Internet resource
Document Type: Internet Resource, Computer File
All Authors / Contributors: Christopher J Mayer; Tomasz Piskorski; Alexei Tchistyi
OCLC Number: 1027314872
Notes: December 2010.
Description: 1 online resource.
Details: Mode of access: World Wide Web.
Series Title: Working paper series (National Bureau of Economic Research), no. w16586.
Responsibility: 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.

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