A recent study cited approvingly by the NY Times, that purports to show that mortgage lenders still discriminate against minorities, doesn’t ask the right question.

Do Mortgage Lenders Still Discriminate Against Minorities?

March 22, 2018

A recent editorial in the NY Times, citing a study by the Center for Investigative Reporting (Reveal), suggests that mortgage lenders still discriminate – that the various regulatory prohibitions that have been imposed since the financial crisis, designed largely to protect minorities, have failed to do so.

In assessing the Reveal study, it is necessary to recognize that historically the home loan market has been afflicted by two types of discrimination. One type arises in connection with accept/reject decisions, where a minority applicant is rejected when an identical white applicant would be accepted. The second type arises in connection with the pricing of a mortgage to accepted applicants, where a minority applicant is charged more than a white applicant with identical qualifications. I will discuss these in turn.

Discrimination in Accept/Reject Decisions

This type of discrimination was widespread in the 1920s and 30s. A mortgage loan applicant then had to visit the office of a bank, savings and loan or insurance company and convince a salaried employee that she was creditworthy. If the employee was prejudiced, or knew his superior was prejudiced, a prejudiced decision to reject the loan would not cost the decision maker anything. A good loan might have been lost, but it was the firm that took the loss rather than the employee who made the decision.

Fast forward to post-World War 2, which saw the rapid growth of secondary markets and mortgage banking, which depends on commissioned loan officers (LOs) for generating mortgage loans that are subsequently sold. The culture of mortgage banking is completely hostile to accept/reject discrimination. This is because the income of LOs is entirely commission-based, dependent on the number of loans they can deliver to the firm. While prejudiced LOs might try to overcharge minority applicants (see below), they never needlessly reject one because that would mean forgoing a commission.

Discrimination in Pricing

On the other hand, the culture of mortgage banking is favorable to price discrimination. While the retail prices posted by lenders for their LOs are subject to regulatory surveillance and free of bias, LOs historically have been free to modify the posted prices “to take advantage of special opportunities”. This meant charging an “overage” which was an addition to the posted rate that was typically shared between the LO and the firm.

Needless to say, minorities paid overages more often than whites. While to some degree this reflected prejudice on the part of LOs, all the LOs that I have ever encountered charged every borrower what they could get away with. Of course, if minority borrowers are easier targets, it doesn’t matter whether the LO is prejudiced or an "equal-opportunity over-charger.”

Mortgage brokers operated on a very similar basis. The posted prices they received from wholesale lenders excluded the broker’s fee, which the broker tacked on. Some added a set markup in every case while others adjusted to what they could get the borrower to accept.

In the regulatory frenzy that erupted after the financial crisis, the compensation of LOs and brokers was scrutinized and in 2011 the Truth in Lending rules were tightened. Today, LOs cannot add an overage to the price, and brokers must post their fee with every lender with whom they do business. Without doubt price discrimination has been markedly reduced as a result. Whether it has been completely eliminated I am not sure, since this has not been studied.

The Reveal Study

In my view, the Reveal study is useless except as ammunition for those who like to view lenders as predators. It deals entirely with discrimination in accept/reject decisions, which has long since ceased to exist. It doesn’t look at price discrimination, which was pervasive before the financial crisis, and has since been subjected to regulatory remedies.

The study presents two kinds of information that allegedly support its view that discrimination in accept/reject decisions is widespread. One source is case histories of rejected loan applicants, about which Reveal says “No matter their location, loan applicants told similar stories, describing an uphill battle with loan officers who they said seemed to be fishing for a reason to say no.”

LOs might indeed fish for a reason to say no when they realize that the applicant cannot possibly meet the underwriting requirements for acceptance. They do not want to waste time on hopeless cases. But LOs never say no to transactions that promise to put a commission in their pocket.

The second type of evidence Reveal presents are rejection statistics reported by lenders under the Home Mortgage Disclosure Act, which always show higher loan rejection rates for minorities than for whites. The problem is that the data do not include credit score or any factors that affect credit score. Other studies have documented that minorities have poorer credit profiles and credit scores than whites. Different rejection rates arising from different credit scores are a social problem with multiple causes, but discrimination by mortgage lenders is not one of them.
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