3.3 Analysis of the code of expectation problems having premature payment

Observe that in case the personal exposure (q) finds out the bonus throughout the bargain will get 0. Up coming only the impacted debtors will pay early, in the event your ex lover post interest remains large. In the scenario away from a lessening interest all of the debtors tend to pay-off very early. Those having exactly who the benefit from the price stays b often pay off early and take up a special borrowing at a lower life expectancy interest rate. The rest, having exactly who the non-public chance has actually understood will pay-off very early. In their eyes the newest gain regarding package might possibly be 0.

It reinvests the fresh repaid loan at the same interest because the brand new credit rates

In the model a risk premium exists only for the first credit and not for the second credit. If the debtor takes up the second credit at the low interest rate ( \(_<2l>)\) the interest rate cannot-by assumption-decline any more in future. The bank cannot impose a risk premium on the second credit, because the bank has no damage if the second credit is also prematurely repaid. In the real world it would however recover its handling costs, which are in the model assumed to be 0. This assumption avoids an infinite regress for the calculation of the risk premium without affecting the main point of the analysis. Otherwise, the calculation for the risk premium of the second contract would require the possibility of a third contract and so forth.

Now assume that the first credit is taken up not in the high interest period but in a low interest period \(_<1>=_<1,l>\) . In that case the future, post contractual interest rate can by assumption not further decline. It is either unchanged or higher. Therefore, in this case the only risk of the bank is that the personal risk q realizes. But a damage cannot occur, because an early repayment allows the bank to either invest the money at the same rate or at an even higher rate. We can therefore exclude this case from further consideration. The expected gain of the debtor from the contract is then

Should your chance superior is roofed clearly, pay day loan Ramah CO we have on questioned obtain away from a card contract, which had been finished during the a top focus period

So it constellation on the model, where in fact the premature payment of borrowing from the bank factors zero damages and you can consequently zero interest mark up is not subsequent felt when you look at the these investigation.

If the legal remedy for early repayment is expectation damages the damage from early repayment is the difference between the contractual and the post-contractual interest rate \(_<1>-_<2>\) . The bank can invest the repaid money at an interest rate of \(_<2>\) . It can, for instance, buy mortgage bonds on the secondary age payment results if and only if \(_<1>>_<2>\) . Otherwise the differential method of damage calculation results in a damage award of zero. The compensation payment is therefore

Let us now assume that after the conclusion of the contract the market interest rate falls, but the benefit from the contract remains at b. We get an outcome which is different in comparison with the result under a right of premature repayment. The debtor wants to end the contract and take out a new mortgage at the low interest rate. With expectation damages as remedy for breach of contract her gain would be \((b-_<2>)-\left( _<1>-_<2>\right)=b-_<1>\) . The term in the first bracket is the consumer’s gain from the new mortgage contract and the term in the second bracket denotes the amount of damages to be paid. The early repayment motivated by the lower interest rate does not result in a gain that is higher than the gain from performance of the contract as originally concluded. Therefore, no early repayment results for taking up a new credit if interest rates decrease after contract formation (Table 2).