The Laibson Plan to End Mortgage Insanity

My Harvard colleague David Laibson (via Justin Fox) has a proposal for dealing with unscrupulous mortgage lenders:

To prevent lending institutions from offering misleading deals that trap borrowers, we should require that all future mortgage loans be prepayable with no penalty. This is an easy, simple rule. The rule will have the effect of leading banks to stop offering many of the teaser rates that serve as loss leaders (pay too little interest for the first 18 months but then pay extra on the back end). These loss leaders are often confusing and tempting for borrowers. Banks won't want to offer loss leaders if borrowers can get out of the loan without paying a penalty after the subsidized payment period -- the teaser period -- ends.

My proposal would not discourage banks from offering sensible adjustable rate mortgages (those without a loss leader component). Borrowers should be allowed to take out a mortgage pegged to short-term rates. That's not a loss leader and such mortgages will still be offered if prepayment is made penalty-free. My proposal will only hit the mortgages with early loss leaders built into the payment stream.

I appreciate the logic here. When I refinanced my mortgage not long ago, one of my first questions was, Are there any prepayment penalties? I figured that as long as the answer was no, I was less likely to be hit with strange, hidden provisions down the road.