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Predatory Lending in a Rational World

42 Pages Posted: 16 Jan 2006  

Philip Bond

University of Washington - Michael G. Foster School of Business

David K. Musto

University of Pennsylvania - Finance Department

Bilge Yilmaz

University of Pennsylvania - Finance Department

Date Written: November 2005

Abstract

Regulators express growing concern over "predatory lending," which we take
to mean lending that extracts excessive rent from borrowers. We present a rational model of consumer credit in which such lending is possible, and we identify the circumstances in which it arises with and without competition. Predatory lending is associated with highly collateralized loans, inefficient rolling over of subprime loans, lending with disregard to ability to pay, prepayment penalties, balloon payments and poorly informed borrowers. Under most circumstances competition among lenders eliminates predatory lending. We use our model to analyze the effects of prominent legislative interventions.

Keywords: Predatory lending, Consumer credit

JEL Classification: G21

Suggested Citation

Bond, Philip and Musto, David K. and Yilmaz, Bilge, Predatory Lending in a Rational World (November 2005). FRB Philadelphia Working Paper No. 06-2. Available at SSRN: https://ssrn.com/abstract=875621 or http://dx.doi.org/10.2139/ssrn.875621

Philip Bond (Contact Author)

University of Washington - Michael G. Foster School of Business ( email )

Box 353200
Seattle, WA 98195-3200
United States

David K. Musto

University of Pennsylvania - Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States

Bilge Yilmaz

University of Pennsylvania - Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States
215-898-1163 (Phone)
215-898-6200 (Fax)

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