In 2005, as a response to concerns over predatory lending, Illinois began to require financial counseling for a very limited number of high-risk mortgage applicants (generally those with a FICO score of less than 620) in a limited number of Chicago zip codes. Although the pilot program was quickly suspended, there was the opportunity to test the program's effect, as Sumit Agarwal et al. do in a new paper just released on SSRN, here.
The study concludes that counseled borrowers appeared to take on less risky mortgage obligations than non-counseled borrowers. Although counseling appeared to reduce the supply of credit and demand for credit among affected borrowers, property values increased and lower foreclosure rates were documented in affected areas. What is especially interesting to me is that, of the borrowers receiving counseling, "an overwhelming majority" of borrowers did not understand that their ARM rate, often a teaser rate, was not fixed over the period of the loan (p. 6) and that over half of applicants received a recommendation from the counselor that they could not afford the loan under consideration (p.7). Albeit limited, the results do illuminate the extreme informational deficit that likely characterized some high risk borrowing in the last few years, and the limits to disclosure as a consumer protection mechanism. While mandated counseling raises a host of other legal & policy concerns (paternalism, discrimination, costs of implementation, just to name a few), the study does present some data that it at least does lead to better-informed borrowers.
