The role of prepayment penalties in mortgage loans |
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| Institution: | 1. Department of Finance, Università Commerciale Luigi Bocconi and SDA Bocconi School of Management, Italy;2. Department of Economics, London School of Economics, United Kingdom;3. Bank of England, United Kingdom;1. McDonough School of Business, Room 427, Georgetown University, 3700 O Street NW, Washington DC, 20057, USA;2. Office of the Comptroller of the Currency, Washington DC, USA;3. School of Finance, Nankai University, 38 Tongyan Road, Tianjin, China 300071 |
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| Abstract: | We study the effect of mortgage prepayment penalties on borrowers’ prepayments and delinquencies by exploiting a 2007 reform in Italy that reduced penalties on outstanding mortgages and banned penalties on newly-issued mortgages. Using a unique dataset of mortgages issued by a large Italian lender, we provide evidence that: 1) before the reform, mortgages issued to riskier borrowers included larger penalties; 2) higher prepayment penalties decreased borrowers’ prepayments; and 3) higher prepayment penalties did not affect borrowers’ delinquencies. Moreover, we find suggestive evidence that prepayment penalties affected mortgage pricing, as well as prepayments and delinquencies through borrowers’ mortgage selection at origination, most notably for riskier borrowers. |
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