Notice that in the event the individual risk (q) realizes the main benefit in the deal will get 0. Following just the influenced debtors tend to repay very early, should your ex blog post interest stays highest. But in happening regarding a reducing interest rate all debtors commonly pay off very early. The individuals to have which the bonus in the deal remains b have a tendency to pay back very early and take right up an alternate credit within a lesser rate of interest. The rest, for who the personal exposure have know also pay-off very early. In their mind the new gain in the offer would-be 0.
They reinvests this new paid mortgage in one interest rate since the fresh new financing price
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 ( \(_)\) 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 \(_=_\) . 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
If the chance premium is included clearly, we become toward requested get of a card price, that has been concluded throughout a leading attention several months
That it constellation regarding the design, where premature repayment out of borrowing from the bank reasons zero problems and for that reason zero interest mark up isnt then believed from inside the the next studies.
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 \(_-_\) . The bank can invest the repaid money at an interest rate of \(_\) . It can, for instance, buy mortgage bonds loans in Lewis on the secondary age payment results if and only if \(_>_\) . 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 \((b-_)-\left( _-_\right)=b-_\) . 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).