The Role of Prepayment Penalties in Mortgage Loans
37 Pages Posted: 24 Mar 2015
Date Written: March 2015
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 before and after the reform, we provide evidence that: 1) before the reform, mortgages issued to riskier borrowers included larger penalties; 2) higher prepayment penalties decreased borrowers' prepayments; 3) higher prepayment penalties did not affect borrowers' delinquencies; and 4) prepayment penalties indirectly affected prepayments and delinquencies through borrowers' mortgage selection at origination, especially for riskier borrowers.
Keywords: mortgages, prepayment penalties
JEL Classification: G21
Suggested Citation: Suggested Citation