Predatory lending practices and subprime foreclosures: Distinguishing impacts by loan category

Abstract

A recent dramatic rise in subprime foreclosures has led to calls for restrictions against a range of loan features loosely termed "predatory." Several cities and states have enacted regulations to curb predatory practices, and some advocacy groups endorse action at the federal level. Using data on subprime refinance and purchase mortgages from the Chicago metropolitan area, I examine the impact of long prepayment penalty periods, balloon payments and reduced documentation on the probability of foreclosure. Results suggest that the relationship between these loan features and foreclosure rates is much more complicated than the arguments for restricting their use assume.

Residential mortgage default: Theory works and so does policy

“…For example, Quercia et al (2005) find that two risk factors, balloon payments and prepayment penalties, increase mortgage foreclosure risk 20-50% on refinance loans. Rose (2008), however, finds that the impacts of the examined loan features on the probability of foreclosure vary significantly across subprime refinances and home purchase mortgages. Alexander et al (2002) finds the risk of default to be higher for loans originated by a third party, such as a mortgage broker.…”

Origination Channel, Prepayment Penalties and Default

“…Prepayment penalties could increase the probability of default if they lower the cost of default relative to the cost of prepayment for financially distressed borrowers, or they could decrease the probability of default if loans with prepayment penalties carry lower interest rates. Quercia, Stegman and Davis (2007), Danis and Pennington-Cross (2008), Rose (2008), Demyanyk and Van Hemert (2011) and Pennington-Cross and Ho (2010) all find that prepayment penalties are associated with greater probabilities of default, although in Rose (2008) and Pennington-Cross and Ho (2010) this result is somewhat dependent on the specification and type of loan used. All of the above papers except Demyanyk and Van Hemert (2011) use competing risk models that jointly consider the probabilities of prepayment and default, and they all find a negative relationship between prepayment penalties and the probability of prepayment, as one would expect.…”

Mortgage Loan Characteristics, Unobserved Heterogeneity and the Performance of United Kingdom Securitized Subprime Loans

“…As a consequence selfcertification is expected to have a positive effect on the predictability of defaulting. Rose (2008) estimates a multinomial logit model with unobserved heterogeneity using securitized subprime loans for the Chicago Metropolitan area from January 1999 and up to mid 2003 and finds that the effects of variables on foreclosure indeed depend upon loan features such as the level of documentation.…”