February 08, 2004

Exploring the Welfare Effects of Risk-based Pricing in the Subprime Mortgage Market

Michael Collins, Eric Belsky, Karl E. Case

BABC 04-8: This paper explores the shift of residential mortgage lending from a system where credit was rationed to prime quality borrowers to a system where subprime borrowers are offered credit using risk-based pricing options. The emergence of risk assessment tools, particularly regarding an applicant’s willingness to pay, in theory can help overcome inefficiencies due to imperfect information available to lenders. This has the potential to complete an otherwise truncated market, add to allocative efficiency, and potentially increase the positive externalities of homeownership. Each of these gains, however, is conditional on how the subprime industry matures and on prevailing consumer and lender practices. Mis-pricing, principal agent distortions and asymmetric information are all potential threats…

Category: Working Papers

Read More About: Housing Markets & Conditions, Homeownership, Affordability