In an earlier
article we reported some interesting mortgage lending information from a
recently released report of The Federal Reserve Board based on data collected
under the 1975 Home Mortgage Disclosure Act (HMDA). The data came from the 8,850
lenders covered by the act and involved over 30.2 million home loan applications.
The real thrust of the survey was to determine patterns in high-priced
lending. High-priced loans are described as those with an interest
rate that is higher by a certain number of basis points above a threshold amount
defined by Regulation C of the HMDA. The report's definition of how to determine
this threshold and the level of variation, both of which vary regularly, took
up several pages of the report. Let us just say that somebody at the Federal
Reserve apparently knows a high-priced loan when they see one.
The mortgage market
has changed a lot over the last decade
and this has impacted the level of higher-priced loans in an interesting way.
Ten or so years ago consumers had a limited selection of mortgage products and
prices varied as dictated by a quite different set of variable than those in
place today. Rates and prices were not determined by the creditworthiness of
the borrower but by loan type (conventional or government backed) the amount
borrowed, owner occupancy, loan term, and the quality of the collateral (stick
built homes vs. manufactured housing; loan to value ratio.) Those borrowers
who fell on the wrong side of these criteria were not charged higher prices;
they just didn't get the loan.
Today, however, lenders price loans primarily on risk so that
differences in the creditworthiness of borrowers can mean different prices for
the same product. "Applicants who are less creditworthy or who are unwilling
or unable to document their creditworthiness or income are increasingly less
likely to be turned down for a loan; rather they are offered credit at higher
This has expanded homeownership opportunities but has led to a segmented
credit market where borrowers fall into three categories; prime
borrowers, i.e. those who always got credit and now get the best deals, and
"subprime" or "near prime" borrowers. Those
in the subprime category typically pay the highest rate because of the risks
they pose; not only a risk that they won't pay on their obligation but that
they will be more likely to prepay their mortgages ahead of schedule once they
have cleaned up their credit, build up equity or increased their income. These
subprime borrowers can also be more costly to service, requiring more monitoring
or greater collection efforts. But, the thresholds that separate these market
segments can change as market interest rates move, as lenders' appetites for
interest rate or credit risk change, as technological improvements allow for
more precise risk assessments.
This flexibility in lending, however, carries a lot of concerns about fairness.
First, are borrowers being shunted into high-priced loans based on discriminatory
criteria such as race or ethnicity? Second, do those persons receiving
high-priced loans have the resources (time, information, financial savvy) to
shop wisely for their loan, and third, is competition adequate to assure that
those borrowers most likely to be extended high-priced products have the full
range of credit opportunities.
The report states that the nonprime market has grown dramatically in recent
years and quotes one source as saying that, from 1994 to 2005 the dollar volume
of subprime loans increased from $35 billion to over $600 billion and subprime
loans are now estimated to make up 20 percent of all mortgage originations compared
to less than 5 percent in 1994.
Subprime loan originations do not correspond exactly with those loans defined
as having prices exceeding the threshold as defined by Regulation C, however
the latter increased significantly in 2005 over 2004 figures. For example, the
incidence of higher-priced lending for conventional, owner-occupied, first-lien
home-purchase loans rose from 11.5 percent in 2004 to 24.6 percent in 2005.
This increase, however, was driven in part by the flattening of the yield curve,
by the yield curve coupled with an artifact of the way APRs on adjustable rate
loans are determined, and borrower or lender-specific changes in the risk characteristics
of lending. These changes in risk characteristics were in part because substantial
increases in house prices in some parts of the country caused more borrowers
to stretch financially to obtain loans.
Analysis of the HMDA data revealed substantial variations in the incidence
of higher-priced lending across racial and ethnic lines and the report states
that these differences could not be fully explained by information in the HMDA
data. Wherever possible analysis included extrapolations from available data
as proxies for missing information.
The 2005 HMDA data indicate that black and Hispanic borrowers are more likely,
and Asian borrowers less likely to obtain loans that cost more than the pricing
thresholds than are non-Hispanic white borrowers. The gross mean incidence of
higher-priced lending for home purchases was 54.7 percent for blacks and 17.2
percent for non-Hispanic whites. When the analysis took into account variables
other than race that effect either borrower or lender this 37.5 percentage point
difference is reduced to about 10 percentage points. When it comes to refinancing
the gross difference between blacks and non-Hispanic whites is 28.3 percent
but this is reduced to 6.2 percentage points after controlling for borrower
and lender factors.
The study found little difference in pricing when borrowers are distinguished
by gender. Sole female borrowers generally have a slightly
lower incidence of higher-priced lending than sole male borrowers for home-purchase
loans but a slightly higher incidence for refinancing.
Analysis of the HMDA data across several years has indicated that loans are
denied at different rates when applicants are grouped by race or ethnicity.
2005 was no exception. For each loan product category, American Indians, blacks,
and Hispanic whites had higher denial rates than non-Hispanic whites; blacks
generally had the highest denial rates and non-Hispanic whites the lowest; Hispanic
whites fall about midway between the two other groups. The denial rates for
Asians relative to other ethnic groups varied across loan products.
As with pricing, controlling for other borrower and lender variables reduced
the disparity in denial rates. For example, blacks had a gross denial rate for
first-lien home purchase loans of 27.5 percent compared to 12.3 percent for
non-Hispanic whites. Accounting for income, loan amount, and other borrower-related
factors reduces the difference by 3.1 percentage points and adding lender factors
to the control reduces the gap to 7.0 percentage points. Refinancing patterns
were very similar.
Denial rates were higher for sole male borrowers than sole females but the
sizes of the differences were small.
This is an extremely dense 45 page report and we have only skimmed the surface
of the information is provides. The full report can be read at www.federalreserve.gov/pubs/bulletin/2006.