Prepayment penalties in residential mortgage contracts: A cost‐benefit analysis

LaCour‐Little, Michael; Holmes, Cynthia

doi:10.1080/10511482.2008.9521651

Cited by 7 publications

(7 citation statements)

References 45 publications

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“…Panel B of Table 8 indicates that for refinance FRMs, prepayment penalties are association with a 34‐basis‐point reduction in loan interest rate. This magnitude is consistent with Elliehausen, Staten and Steinbuks (2008) and somewhat larger than that found by LaCour‐Little and Holmes (2008). Bank originators appear to provide discounts on loan rates for prepayment penalties that are almost 25 basis points greater than the discounts provided by nonbank originators, consistent with H2.…”

Section: Empirical Analysissupporting

confidence: 79%

“…The analysis of the pricing of prepayment penalties is similar to Elliehausen, Staten and Steinbuks (2008) and LaCour‐Little and Holmes (2008), who use instrumental variable approaches to address the endogeneity of loan interest rates, LTV ratios and prepayment penalties. This approach is applied here to all loans, only bank‐originated loans and only nonbank‐originated loans to examine how the impact of prepayment penalties on loan prices differs by origination channel.…”

Section: Methodsmentioning

confidence: 99%

“…A small number of papers examine differences in subprime mortgage interest rates based on origination channel, with inconsistent results. LaCour‐Little and Holmes (2008) and El‐Anshasy, Ellieausen and Shimazaki (2005) find that broker originations have lower loan rates and lower APRs, respectively. Elliehausen, Staten and Steinbuks (2008) find that broker originations generally have higher rates, with larger differences for fixed‐rate mortgages (FRMs) than for hybrid adjustable‐rate mortgages (ARMs).…”

Section: Literature Reviewmentioning

confidence: 99%

“…DeMong and Burroughs (2005) find prepayment penalties to be associated with lower interest rates for both FRMs and ARMs, while Ernst (2005), whose sample includes only FRMs, finds prepayment penalties to be associated with higher rates for purchase FRMs and to have no significant relationship with refinance FRM rates. Elliehausen, Staten and Steinbuks (2008) and LaCour‐Little and Holmes (2008) use multiple‐equation approaches controlling for endogeneity among loan interest rates, loan‐to‐value (LTV) ratios and prepayment penalties. Both find that prepayment penalties are associated with lower interest rates, with the reduction being more pronounced for FRMs than ARMs.…”

Section: Literature Reviewmentioning

confidence: 99%

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Origination Channel, Prepayment Penalties and Default

Rose¹

2012

Real Estate Economics

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This article presents evidence that nonbank-originated subprime mortgages have a higher probability of default than bank-originated subprime mortgages, but only for loans with prepayment penalties. Evidence also indicates that nonbanks price prepayment penalties less favorably to borrowers than banks do, and nonbanks originate disproportionately more loans with prepayment penalties in locales with less financially sophisticated borrowers. State antipredatory lending law provisions restricting the use of prepayment penalties eliminate the elevated default risk of nonbank originations relative to bank originations. These findings are consistent with incentives generated by nonbank compensation via yield spread premiums on loans with prepayment penalties.Of broad concern for our understanding of the recent foreclosure crisis and for housing and financial stability moving forward is the role of compensation incentives across origination channels in mortgage lending. The specific aspect of this concern addressed in this article is whether and why subprime loans originated by relatively less-supervised nondepository institution mortgage originators ("nonbanks") performed worse than subprime loans originated by depository institutions ("banks") primarily supervised by one of the federal financial regulatory agencies: the Federal Reserve, Office of the Comptroller of the Currency (OCC), Federal Deposit Insurance Corporation, Office of Thrift Supervision (OTS) or National Credit Union Association. 1 Results indicate that nonbank originations have a higher probability of default than bank originations, but only for loans that include prepayment penalties. This is the first evidence linking greater default risk across origination channels to a specific loan feature and is consistent with a greater importance of yield spread premiums (YSPs) in compensation among nonbank originators than bank originators. * University of Maryland, Baltimore County, Baltimore, MD 21250 and Office of the Comptroller of the Currency, Washington, DC 20219 or mrose@umbc.edu. 1 Many examinations of mortgage lending by origination channel distinguish between originations by direct lenders ("retail") and by brokers ("wholesale"). Here, nonbank originations include both broker originations and originations by direct lenders that are not depository institutions. As is explained in the data and methodology section, the use of this categorization of origination channel is determined by data availability. C 2012 American Real Estate and Urban Economics Association 2 RoseThe article then presents further evidence that disparities by origination channel in pricing prepayment penalties, borrower financial sophistication and the role of antipredatory lending laws are also consistent with differing compensation incentives.The remainder of this article consists of six sections. The following two sections provide background information and discuss the relevant previous literature. The next sections present the article's hypotheses, describe the article's data so...

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Section: Empirical Analysissupporting

confidence: 79%

Section: Methodsmentioning

confidence: 99%

Section: Literature Reviewmentioning

confidence: 99%

Section: Literature Reviewmentioning

confidence: 99%

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Origination Channel, Prepayment Penalties and Default

Rose¹

2012

Real Estate Economics

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“…According to Standard & Poor's (2004), approximately 80% of subprime loans contained prepayment penalties as of 2000. The substantial use of prepayment penalty is confirmed by Elliehausen, Staten and Steinbuks (2008) and LaCour‐Little and Holmes (2008), who, respectively, reported that about 60% and 90% of their subprime loan samples contained a prepayment penalty.…”

Section: Background On Prepayment Penaltymentioning

confidence: 89%

Prepayment Penalty as a Screening Mechanism for Default and Prepayment Risks

Bian

Yavaş

2012

Real Estate Economics

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The objective of this article is to offer a theoretical model of asymmetric information to analyze the screening role of prepayment penalty. We consider both default risk and prepayment risk. What makes the role of prepayment penalty interesting and more complicated is that a borrower's contract choice could send conflicting signals to the lender about that borrower's default and prepayment risk type. This is different from earlier theoretical models of mortgage choice under asymmetric information where a certain aspect of the contract (e.g., discount points or loan‐to‐value ratio) is explored as a screening mechanism for a single risk dimension (default risk or prepayment risk) of the borrower type. We show the existence of separating equilibria where different default and prepayment risk types choose contracts with different combinations of prepayment penalty and interest rate. For certain parameter combinations, the model also generates a pooling equilibrium where all borrower types obtain the same contract. Our analysis could offer a partial explanation for the observation that contracts with prepayment penalties are a lot less prevalent than contracts with points.

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