The properties of nonsophisticated borrowers’ competitive-equilibrium contracts, and the restriction disallowing disproportionately large penalties for deferring small amounts of repayment, have close parallels in real-life credit markets and their regulation. As has been noted by researchers, the baseline repayment terms in credit-card and subprime mortgage contracts are typically quite strict, and there are large penalties for deviating from these terms. For example, most subprime mortgages postulate drastically increased monthly payments shortly after the origination of the loan or a large “balloon” payment at the end of a short loan period, and failing to make these payments and refinancing triggers significant prepayment penalties
