Financial Education versus Costly Counseling: How to Dissuade Borrowers from Choosing Risky Mortgages?

Abstract

This paper explores the effects of mandatory third-party review of mortgage contracts on consumer choice. The study is based on a legislative pilot carried out in Illinois in 2006, under which mortgage counseling was triggered by applicant credit scores or by their choice of “risky mortgages.” Low-credit score applicants for whom counselor review was mandatory did not materially alter their contract choice. Conversely, higher-credit score applicants who could avoid counseling by choosing non-risky mortgages did so, decreasing their propensity for high-risk contracts between 10 and 40 percent. In the event, one of the key goals of the legislation—curtailment of high-risk mortgage products—was only achieved among the population that was not counseled.

Keywords: Financial counseling, subprime crisis, predatory lending, household finance

JEL Classification: D14, D18, L85, R21