TY - JOUR
T1 - The inefficiency of refinancing
T2 - Why prepayment penalties are good for risky borrowers
AU - Mayer, Chris
AU - Piskorski, Tomasz
AU - Tchistyi, Alexei
N1 - Funding Information:
We thank Chester Spatt for many helpful comments and suggestions. We also thank the editor, Patrick Bolton, Bruce Carlin, Douglas Diamond, Mark Garmaise, Mikhail Golosov, Randall Kroszner, David Laibson, Karen Pence, Mitch Peterson, Amit Seru, Jeremy Stein, Suresh Sundaresan, Aleh Tsyvinski, Stijn Van Nieuwerburgh, Neng Wang, and seminar participants at Columbia Business School, University of California at Berkeley, Harvard University, Chicago Fed, University of California at Irvine, AEA Annual Meeting, NBER Corporate Finance meeting, NBER Housing and Public Policy meeting, Stanford Institute for Theoretical Economics meeting, NYC Real Estate Meeting, University of Virginia Law School conference on “Law and Economics of Consumer Credit”, SED meeting, Summer Real Estate Symposium, and AREUEA summer and annual meetings for helpful comments and suggestions. Adam Ashcraft, Andrew Haughwout, Andreas Lehnert, Karen Pence, and Joe Tracy provided invaluable help in putting together and understanding the data. Alex Chinco, Daniel Hubbard, Rembrandt Koning, and James Witkin provided excellent research assistance and helpful modeling suggestions. The research was supported by the Paul Milstein Center for Real Estate at Columbia Business School.
PY - 2013/3
Y1 - 2013/3
N2 - This paper provides a theoretical analysis of the efficiency of prepayment penalties in a dynamic competitive lending model with risky borrowers and costly default. When considering improvements in the borrower's creditworthiness as one of the reasons for refinancing mortgages, we show that refinancing penalties can be welfare improving and that they can be particularly beneficial to riskier borrowers in the form of lower mortgage rates, reduced defaults, and increased availability of credit. Thus, a high concentration of prepayment penalties among the riskiest borrowers can be an outcome of efficient equilibrium in a mortgage market. We also provide empirical evidence that is consistent with the key predictions of our model.
AB - This paper provides a theoretical analysis of the efficiency of prepayment penalties in a dynamic competitive lending model with risky borrowers and costly default. When considering improvements in the borrower's creditworthiness as one of the reasons for refinancing mortgages, we show that refinancing penalties can be welfare improving and that they can be particularly beneficial to riskier borrowers in the form of lower mortgage rates, reduced defaults, and increased availability of credit. Thus, a high concentration of prepayment penalties among the riskiest borrowers can be an outcome of efficient equilibrium in a mortgage market. We also provide empirical evidence that is consistent with the key predictions of our model.
KW - Inefficiency of refinancing
KW - Mortgages
KW - Prepayment penalties
KW - Risky borrowers
UR - http://www.scopus.com/inward/record.url?scp=84875512443&partnerID=8YFLogxK
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U2 - 10.1016/j.jfineco.2012.10.003
DO - 10.1016/j.jfineco.2012.10.003
M3 - Article
AN - SCOPUS:84875512443
SN - 0304-405X
VL - 107
SP - 694
EP - 714
JO - Journal of Financial Economics
JF - Journal of Financial Economics
IS - 3
ER -