The Price and Adverse Effects of Consumer Protection for the Protected. A Panel Study on Consumers' Right to Early Repayment of Mortgage Loans in the EU-Member States

Abstract

Increasing consumer protection shifts contractual risks from consumers to suppliers. This raises marginal costs and equilibrium prices. Increasing consumer protection is therefore not without cost. In a cross-country study on European mortgage markets we tested the hypothesis that (all other important determinants of mortgage interest rates controlled for) making consumer protection legislation more stringent leads to higher consumer mortgage interest rates if debtors are permitted to repay their loans at any time without paying damages to the bank. Using monthly panel data collected for twenty-three EU Member States in the period from 2006 to 2016 we find that Member States with high consumer protection levels have higher mortgage interest rates than countries with low protection levels. We subsequently question the assumption that a high level of protection is justified. First, consumer protection leads to cross subsidization of high risk consumers by low risk consumers for instance from people who are not on the job market to those who are and who are therefore more likely to sell their properties and repay the loans prematurely. Second, consumer protection allows debtors to repay their loans if interest rates fall, take out a new loan at a lower interest rate and thus make a windfall profit, without making any losses if interest rates remain constant or rise. This benefits only risk-loving debtors and harms risk averse debtors and is not in line with a reasonable concept of consumer protection. We show this in a formal model that helps us to discuss under what conditions a policy on premature repayments can lead to an increase in consumer welfare.