Do Financial Counseling Mandates Improve Mortgage Choice and Performance?

We explore the effects of mandatory third-party review of mortgage contracts on the terms, availability, and performance of mortgage credit. Our study is based on a natural experiment in which the State of Illinois required ‘high-risk’ mortgage applicants acquiring or refinancing properties in 10 specific zip codes to submit loan offers from state-licensed lenders to review by HUD-certified financial counselors. We document that the legislation led to declines in both the supply of and demand for credit, with state licensed lenders and lower-quality borrowers disproportionately exiting the affected area. Controlling for the salient characteristics of the remaining borrowers and lenders, we find that the legislation succeeded in reducing ex post default rates among counseled borrowers by close to 4 percentage points (about 35% decline). We attribute this result to actions of lenders responding to the presence of external review and, to a lesser extent, to counseled borrowers renegotiating their loan terms. We also find that the legislation nudged some borrowers to choose less risky loan products in order to eschew counseling