Residual-debt insurance and mortgage repayments

Mortgagors insured against negative home equity are less likely to partially prepay their mortgage debt compared to those without the insurance. We identify the effect of insurance on prepayments combining two strategies. First we use a regression discontinuity design, enabled by the acceptance criteria of the Dutch insurance which is only accessible for houses below a legislated threshold. After that we add information on (unexpected) intergenerational transfers to the borrowers. We find that insured borrowers make 22.8% lower prepayments relative to their original debt, and we propose that this could be explained by moral hazard. As this insurance was an ‘offer you cannot refuse’, this is a more likely explanation than adverse selection.

Keywords: moral hazard; mortgage insurance; mortgage prepayment
JEL codes D14; G21; G51

Working paper no. 823