I've heard in the news recently that lenders are targeting their sub-prime marketing efforts towards minorities. Why is this?
Lenders target their sub-prime marketing efforts towards racial and ethnic minorities largely as a strategy to extend loans to these groups while simultaneously guarding against the risk of default. In light of the historical claims of discrimination against minorities in the lending market, lenders have more recently been making concerted efforts to issue loans to minorities under sub-prime programs.
Relative to other groups, minorities have long experienced difficulty obtaining mortgages under standard lending criteria. Because racial and ethnic minorities disproportionately fall into lower socioeconomic classes and consequently have lower-and even impaired-credit ratings, they have traditionally been less likely to qualify for most mortgage plans. As a result, the rate at which their loan applications have been turned down has been much higher than that for whites. This situation has become an important cause for concern. Most significantly, it has stimulated much thought about possible racial discrimination in the lending market to minorities' detriment. In response to such claims, the federal government began to focus heavily on the issue in the 1970s and enacted the Community Reinvestment Act of 1977 to increase fairness in lending among minority neighborhoods. It also began levying tens of millions of dollars in fines against discriminatory lenders.
Feeling the pressure to reach out to underserved neighborhoods and communities, many banks discovered that they could indeed lend to low- and moderate- income residents by charging higher fees for their loans. This type of loan is called a sub-prime loan, and it was first made possible in the 1980s when the federal government lifted mortgage interest ceilings. It became a common and profitable practice just one decade later.
Sub-prime loans are made without regard for the borrower's ability to repay them. They are typically made to borrowers with credit troubles or limited credit histories who do not qualify for less expensive prime loans. Sub-prime loans carry high interest rates, fees, heavy prepayment penalties, and significant credit insurance. The costs are much higher than those of their prime counterparts.
Lenders claim that targeting minority groups with sub-prime marketing programs is necessary-they must charge them higher interests rates to cover the increased underwriting risk they assume by extending them loans. They assert that they were criticized when they did not lend in minority neighborhoods. As such, they see sub-prime lending to minorities as a way to lend to more minorities without overexposing themselves to heightened risks of loss on their loans.