Risk-Based Mortgage Pricing: Present and Future Research

Abstract

The policy debate surrounding predatory lending laws and the subprime mortgage market opposes two hypotheses. The first is that an efficient market is providing broader access to credit, offering mortgages with higher rates and fees to higher risk borrowers, and that prices relate directly to the added risk. The contrary hypothesis is that high interest rates and loan fees are charged in the subprime market well in excess of the risk-related costs.

A number of readily observed facts about the subprime mortgage market support the opportunity pricing hypothesis. Existing research includes simple descriptive price information, papers inferring a correlation between high prices and high risk of credit loss from observed default rates, theoretical discussions to explain the observed pricing dispersion, and studies trying to determine whether laws that indirectly restrict mortgage prices have reduced the supply of mortgage credit. Information asymmetries, seller obfuscation and search costs contribute to the observed inefficiencies in this market, and suggest several policy responses.

Keywords: Risk-Based Pricing, mortgage, subprime, predatory lending

JEL Classification: D12,D43, L11