The Economic Effects of Legal Restrictions on High-Cost Mortgages

Abstract

We analyze the effects of state predatory mortgage lending laws, which have been a model for recent changes in the United States Federal legislation enacted to regulate the mortgage contract terms common in higher-risk mortgage market segments. Using the Rothschild-Stiglitz approach to model credit markets under asymmetric information legal restrictions are shown to reduce the use and attractiveness of mortgage credit. Consistent with model predictions, empirical results indicate that originations of regulated high-cost mortgages were significantly less than predicted in states with more restrictive laws. The differences between predicted and actual originations of high-cost mortgages in states with less restrictive laws were not significant. These differences were also not significant for non-high-cost originations across all states. Thus, credit regulation was differentially associated with reduction in originations of high-cost mortgages, and non-high-cost lending did not consistently expand in areas where high-cost mortgages were restricted.

Keywords: Dodd-Frank Act; High-cost mortgages; Mortgage credit; Prepayment penalties; Subprime lending