With Feeling, Ban Prepayment Penalties At The Federal Level

So, no vanilla contract. And there’s more.

Other Exemptions…the following businesses will not be subject to CFPA regulation for acting in their traditional capacities…Accountants and other businesses that perform tax preparation services…Real estate brokers and agents…Consumer reporting agencies…

I’m working on a longer piece about how shady the consumer reporting agencies can be, so it’s a shame to see them exempt. But real estate brokers and agents? If brokers are exempt, that is clearing the way for yield spread premiums being exempt from consumer protection, which is super shady (watch wikipedia do the pretzel in that link: “YSPs as a financial instrument are not controversial. What is controversial is the fact that brokers and lenders have different disclosure requirements regarding their existence…”).

Since I get the feeling that the capture will grow, I’m going to renew my call for a very simple deal: Ban Prepayment Penalties at the Federal Level. It’s blunter than the vanilla option, but it’ll work with getting the worst out of the market.

I’ve written a lot on this topic. Have you ever had a thought, and think you are kind of a deal for having it, and then realize someone said it better like years ago? Well, here’s Justin Fox and Harvard Behavioral Economist David Laibson’s presenting the Curious Capitalist World Exclusive Plan For Helping Consumers by Banning Prepayment Penalties At The Federal Level (from August 2007 !!!):

Now Harvard economist David Laibson, whom I mentioned in the previous post as an expert on “hyperbolic discounting”–academicspeak for the human tendency to pay too little attention to costs and benefits in the distant (and sometimes not so distant) future–has come forward with a simple proposal to end teaser madness. Here it is, a Curious Capitalist World Exclusive:

“To prevent lending institutions from offering misleading deals that trap borrowers, we should require that all future mortgage loans be prepayable with no penalty. This is an easy, simple rule. The rule will have the effect of leading banks to stop offering many of the teaser rates that serve as loss leaders (pay too little interest for the first 18 months but then pay extra on the back end). These loss leaders are often confusing and tempting for borrowers. Banks won’t want to offer loss leaders if borrowers can get out of the loan without paying a penalty after the subsidized payment period — the teaser period — ends.

My proposal would not discourage banks from offering sensible adjustable rate mortgages (those without a loss leader component). Borrowers should be allowed to take out a mortgage pegged to short-term rates. That’s not a loss leader and such mortgages will still be offered if prepayment is made penalty-free. My proposal will only hit the mortgages with early loss leaders built into the payment stream.”

Yup, that says it all incredibly well. And in two paragraphs. Also notice the framing – from here on out, it’ll be “all future mortgage loans be prepayable with no penalty.” It’s the same statement, but it emphasizes what is important here.

Political Will

It’s a very simple request. It may even be able to get wider support. Lots of Democratic candidates called for it during the 2007 election. Here’s Chris Dodd in 2007, calling for eliminating prepayment penalties. Here’s Hillary Clinton also on board with eliminating prepayment penalties in 2007.

It may also be able to get bipartisan support. It wouldn’t outlaw option ARMs. It would outlaw ones that are only profitable to give when people are trapped. It would reduce the transaction costs in housing, which would keep labor more flexible. These are good things, that make the economy at large stronger and healthier. Even Greg Mankiw appreciates the Fox/Laibson plan, saying “Are there any prepayment penalties? I figured that as long as the answer was no, I was less likely to be hit with strange, hidden provisions down the road.” I hope some politicians are also able to appreciate it just as much.

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5 Responses to With Feeling, Ban Prepayment Penalties At The Federal Level

  1. So who IS regulated by this agency? Will mortgage brokers who hand out loans to people without income to support them be subjected to stiff penalties for engaging in this stupid business practice? Or are they exempt too?

  2. q says:

    i’ve been through your mortgage prepayment posts and i’m confused about your logic. you seem to be conflating “prepayment fees” with “banks taking house price risk”. i don’t understand your logic here. banks take house price risk when they don’t demand sufficient equity capital (ie 20% down); as far as i can tell that’s the whole story. could you elucidate?

  3. q says:

    > It would reduce the transaction costs in housing

    you are saying that if there are penalties for refinancing, more people will refinance.
    on the face of it, the opposite is true. please explain.

  4. q says:

    sorry, i meant

    > It would reduce the transaction costs in housing

    you are saying that if there are no penalties for refinancing, fewer people will refinance.
    on the face of it, the opposite is true. please explain.

  5. Sam G. says:

    @q

    If the cost of buying and selling a home are void of penalty fees, then labor will be able to move more easily is what he’s trying to say, I think.

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