Consumers’ Right to Early Repayment of Mortgage Loans in the EU-Member States, a Case of Misguided Consumer Protection

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 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 often leads to an impairment of consumer welfare, compared with the traditional rule of expectation damages for breach of contract. This applies especially if the consumer repays the loan in a low interest rate phase to take up a new credit at lower interests. From a theoretical point of view, this right has thus no solid economic underpinning, if it is not restricted to cases of personal hardship of the consumer and serves an insurance function. We additionally present empirical evidence that supports this argument, among others 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.