Abstract
Consumer protection shifts risks from consumers to businesses. This raises marginal costs and equilibrium prices. It is justified when markets are not strong enough to allocate contractual risks or accident risks efficiently, especially in cases of severe asymmetric information between suppliers and consumers. Consumer protection can then increase the consumer’s expected welfare from a contract. We test these considerations in a theoretical and empirical study on consumers' right to early repayment of mortgage loans without damage compensation to the creditor in the European Union. We show in a formal model that such a right can lead to an impairment of consumer welfare, compared with the traditional rule of expectation damages for breach of contract. This applies if the consumer is risk averse and repays a loan with a high interest rate in a low interest period to take up a new loan for the same project at lower interests. From a theoretical point of view, this right has no solid economic underpinning, if it is not restricted to cases of personal hardship of the consumer and serves an insurance purpose. We present empirical evidence supporting this argument. In a panel study on monthly mortgage interest rates of 23 EU Member States between 2005 and 2017 we show how interest rate spreads change with the level of consumer protection.
Highlights
In this paper we present a theoretical and empirical analysis of different consumer protection rules in the European Union in case of the premature repayment of a mortgage credit
Our results show that making consumer protection for the case of early repayment more stringent results in an increase in interest rates for long-term consumer mortgages
This paper shows analytically that a right to early repayment of a long-term mortgage consumer credit with fixed interest rates in European consumer protection law might decrease rather than increase consumer welfare
Summary
In this paper we present a theoretical and empirical analysis of different consumer protection rules in the European Union in case of the premature repayment of a mortgage credit. The level of consumer protection is not uniform under EU Law. The Mortgage Credit Directive (European Parliament & Council, 2014) is on this dimension a skeleton law, which gives discretion to Member States to legally entitle their national banks to either negotiate a price for the premature ending of the credit contract, or charge full expectation damages, or to allow early repayment without any damage compensation, or to cap the damage award. In line with our theoretical findings, our empirical results indicate that the expected costs of consumer protection are passed on to consumers via the interest rate spread, that is the difference between the lending and the refinancing interest rate of mortgage banks They tentatively support our view that interest rate spreads increase more than proportionately with rising market interests if compensation of expectation damages for early repayments is either abolished or severely capped.
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