Does Mandatory Loan Review Affect Mortgage Contract Choice and Performance?

Itzhak Ben-David, Sumit Agarwal, Gene Amromin, Souphala Chomsisengphet and Douglas Evanoff

No 2011-WP-12, NFI Working Papers from Indiana State University, Scott College of Business, Networks Financial Institute

Abstract: We explore the effects of mandatory third-party review of mortgage contracts on the terms, availability, and performance of mortgage credit. Our study is based on a legislative pilot carried out by the State of Illinois in a selected set of zip codes in 2006. Mortgage applicants with low FICO scores were required to attend loan reviews by financial counselors. Applicants with higher FICO scores had to attend counseling only if they chose 'risky mortgages.' We find that low-FICO applicants for whom counselor review was mandatory did not materially change their contract choice. Conversely, applicants who could avoid counseling by choosing less risky mortgages did so. Although ex post default rates among low-FICO borrowers in the pilot program declined by 25%, we find that the educational component of counselor review played only a minor role. Instead, external review presented strong incentives for lenders to impose tighter ex ante screening on low-credit-quality borrowers.

Keywords: Financial counseling; screening; subprime crisis; household finance (search for similar items in EconPapers)
JEL-codes: D14 D18 L85 R21 (search for similar items in EconPapers)
Pages: 51 pages
Date: 2011-05
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