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Volume 19, Issue 4
Affordable Housing in New Urbanist Communities: A Survey of Developers
Comment: McIlwain
Comment: Dietz
Prepayment Penalties in Residential Mortgage Contracts: A Cost-Benefit Analysis
Mobility and Exit from Homeownership: Implications for Community Reinvestment Lending
Fostering Low-Income Homeownership through Individual Development Accounts: A Longitudinal, Randomized Experiment
State Innovations in Affordable Housing Policy: Lessons from California and New Jersey
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Prepayment Penalties in Residential Mortgage Contracts: A Cost-Benefit Analysis
Volume 19, Issue 4
2008
 
Michael LaCour-Little and Cynthia Holmes
 
Prepayment penalties are ubiquitous in the commercial mortgage market yet reviled and highly restricted by law and regulation in the residential mortgage market. Considering the perspectives of both the borrower and the lender, we attempt a balanced cost-benefit analysis of this controversial contract feature for residential mortgage loans.

We will address the following questions: What is the economic value of the prepayment penalty feature? Why is it more prevalent in the subprime than the prime market segment? Do borrowers obtain an offsetting economic benefit when they contract for a loan containing a prepayment penalty? What is the average cost of a prepayment penalty to borrowers, and how often is this cost actually incurred? In general, although we find a significant reduction in interest rates for loans containing a prepayment penalty, the expected costs outweigh the benefits by a considerable margin.
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