Rates Relations

November 18, 2005
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GRAND RAPIDS — The mortgage lending industry turns down minority applicants at a higher rate than it does whites. Blacks and Hispanics that do get approved for loans pay higher interest rates.

Looking at the data compiled through the Home Mortgage Disclosure Act, it’s easy to come to the conclusion that lenders offer preferential treatment for Caucasians. Whether that conclusion — like many that are made by quickly skimming over the summary of an enormous, complicated data set — may be based on faulty assumptions is a matter of debate.

The Federal Reserve recently concluded a study of the HDMA data to examine the issue of potential discrimination; as a result, the Fed is investigating 200 as-yet-unidentified institutions, about 2 percent of those in the study. Those investigations spring from new information collected for the first time in 2004.

In Grand Rapids, the Inner City Christian Federation is the leading source for providing home ownership education to low-income individuals. Approximately 80 percent of the organization’s clients are minorities. Jonathan Bradford, ICCF’s executive director, said that minorities looking to purchase a home often face many obstacles. He said the issue of racial discrimination in lending “is an extremely difficult issue to address.”

“Because unfortunately, race and credit difficulty, race and employment irregularity or volatility, are related. But the question is: Is it a causal relationship? And that’s an extremely delicate thing to be able to answer. I mean, fundamentally, there clearly is unequal access to credit in the minority community. But to say it is wholly and solely because of skin color is the tough thing,” said Bradford.

Rodney Martin, a finance attorney at the Grand Rapids firm of Warner Norcross & Judd, recently presented a summary of the Fed study to the Michigan Bar Association. Martin said that blacks received subprime loans nearly four times as frequently as whites. Hispanics were about twice as likely as whites to end up with a high-priced loan.

The Fed study found non-racially motivated rationale that might explain the differences in the incidence of high-priced loans among races. The report said that two-thirds of that difference could be attributed to “differences in the groups’ distribution of income, loan amounts, other borrower-related characteristics included in the HDMA, and the lender.”

Martin said that, making those adjustments, the Fed found that the likelihood of receiving high-priced loans showed a much weaker correlation to race.

Sue Ortiz, manager of ICCF’s housing education programs, agreed that the issue is complicated.

“I wouldn’t want to go out on a limb and say that it’s just race. … But I do know that statistics show that there is so much subprime lending targeted at minority neighborhoods and the elderly,” she said. “Any time that a person gets subjected to a subprime or predatory loan when they have an opportunity elsewhere, it’s really a travesty. And we’re really trying to combat that a lot by getting the word out to people about access to better mortgages.”

Since the 1970s, the government has collected mortgage data in an effort to monitor home lending trends. Each year, HDMA reports show the number of loans made by reporting banks, along with critical data including the general location of the purchased property and limited personal information about the buyers — such as gender and race. Unlike past HMDA data, the 2004 data set includes information related to loan pricing. As the council put it, “the pricing data are intended to advance enforcement of consumer protection and anti-discrimination laws and to improve mortgage market efficiency.”

The new information has led to some uproar about racial discrimination in the mortgage lending industry. Federal Reserve Board Governor Mark W. Olson recently addressed the matter at a conference of the Consumer Bankers Association in Arlington, Va.

“The current concern about the release of the new pricing data is reminiscent of the concern about the first release, 15 years ago, of data on race and sex. Those data, and the studies surrounding their release, raised serious questions about whether the mortgage market was serving people of all races fairly. In 1989, the concern was whether minority borrowers were denied mortgage loans more frequently than white borrowers and, if so, whether the disparity reflected discrimination. Today, the issue is no longer limited to whether minority borrowers have access to credit but, rather, whether the price of that credit reflects the lender’s risk or whether it is tied in any way to discrimination.”

So did the 2004 data show evidence of discrimination? Possibly, but not conclusively. The data showed that minorities are more likely to be sold the subprime high price loans — those with interest rates 3 percent or more above a benchmark set by the Department of Treasury. Of mortgages made to blacks, 29.4 percent were subprime. Among Hispanics, the rate was 15.3 percent. Of loans made to whites, 10.4 percent were high-priced.

What the data did not show is whether minorities were steered into more expensive loans because of any prejudice on the part of the lender, or whether minorities tended to use lenders that offered more high-rate loans, or whether other factors such as poor credit or high debt-to-income ratios were more common among minority borrowers.

Martin pointed out that high-priced lending is not endemic to the mortgage industry. Of the 8,853 institutions included in the HMDA data, 3,300 had not made a single high-priced loan in 2004. An additional 2,300 made fewer than 10. The data showed that a small number of lenders accounted for a great deal of the high-priced loan business across the country. In fact, just 10 lenders accounted for 38 percent of all of the nation’s subprime lending in 2004.

To further examine the issue, Martin looked at the pricing magnitude included in the data. If the differences in pricing were based upon racial prejudice, it would follow that all whites would receive better rates than minorities, even those whites who received high-priced loans. Or, in other words, they would receive high-priced loans of lower magnitude. But that was not the case. Among people of all races who received high-priced loans, there were negligible differences between the rates they were charged.

“It’s amazing how close it is. Those numbers are almost identical,” said Martin. “So at least we know on a national basis, based on these data, that borrowers who received a high-priced loan were treated similarly in terms of the rate that was charged. So that’s good. That’s very good.”

What’s not good is accepting a high-priced loan when a more affordable option may be available. That’s where education makes a big difference, according to Ortiz.

“Quite often we see a lot of similarities in the problems that people experience, regardless of race,” she said. “Unless the person has the knowledge to ask the question, or the experience behind them that gives them an opportunity to really look at the big picture of what they’re getting themselves into, they’ll simply sign … and deal with the problem later.”

Ortiz said that two changes in the mortgage industry have increased borrowers’ risk of ending up with loans that do not serve their best interests.

First, as rates have decreased, the industry has sought a higher loan volume to maintain its level of business. That means making riskier loans. She said that people who would have been turned down for loans 10 years ago are now being accepted, but that they are paying those subprime rates to compensate for the risk associated with their poor credit or spotty work history.

The other change is the heavy reliance on credit scores without considering other factors. For minority borrowers, that can be good news and bad.

“They have moved to a more automated system driven by hard numbers. So you look at ratios. You look at credit scores and that determines your risk,” said Martin. “So to the extent that you take out the judgment of the individual loan officer, and put it into a risk-based system, you reduce or eliminate the opportunity for any prejudices that the individual loan officer may have, or the opportunity for any loan officer to take advantage of an individual so they can make a good deal. So this is really a very clear statement that risk-based lending can work.”

But excluding the loan officer’s individual judgment is a double-edged sword, according to Ortiz.

“I think that in theory, the whole push toward credit score usage in lending is good,” she said. “However, taking the whole picture into account in making a lending decision is missing. So, in the old days, if someone was a good, hard worker but had run into some trouble, they might lend to them anyway — just take that risk. So, removing the ability to really know a person and to know what kind of background they have and what sort of problems they’ve run into, not really allowing for an explanation can, in the long run, harm someone’s ability to get a good loan. Often times a credit score just does not catch up with a person who has been working very hard to correct problems.”    

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