What We Know About Mortgage
Lending Discrimination In America

Expanding the Knowledge Base

The evidence and analysis summarized in this report provide persuasive evidence that discrimination in home mortgage lending persists. Although we do not yet have reliable measures of the incidence of discrimination at each stage in the lending process, systematic monitoring and enforcement efforts are clearly justified by existing evidence that discrimination occurs at significant levels. But serious gaps remain in our collective knowledge about the incidence of discrimination, the forms it takes, and the circumstances in which it is most likely to occur. More comprehensive information is needed to help shape effective policy. For example:

• Regulators need reliable data on the incidence of discrimination in different markets and at different stages in the mortgage lending process to effectively allocate scarce enforcement resources.
• Proven methods for detecting discrimination would help regulators and private fair housing groups monitor the performance of individual lending institutions, and might encourage some lenders to monitor their own performance.
• Better knowledge about the forms that discrimination takes and the reasons why institutions and individuals continue to discriminate would contribute to the design of discrimination remedies and best practices.
• Lenders need information about how parts of their organization might be discriminating, and about effective strategies for ending discrimination.

Thus, gaps in the existing body of evidence about lending discrimination limit the capacity of policy makers, regulators, advocates, and lending institutions to design effective enforcement policy, target enforcement resources to the circumstances in which discrimination is most likely to occur, implement corrective remedies, and monitor the effectiveness of these remedies over time. This section outlines five key areas where more information and analysis can and should be assembled to inform both public policy and private action.

Launch Expanded Research on Office Locations, Outreach, and Referrals

Relatively little research has focused on the extent to which lenders may discriminate by avoiding or limiting contact with minority customers. Evidence from litigation suggests that some lending institutions locate their offices in predominantly white areas. It is also possible that some lenders target direct mail solicitations to white communities, or get their referrals primarily from real estate agents who serve white neighborhoods. If so, advertising and outreach practices steer minority and white borrowers to different lending institutions (which may offer unequal products and services). However, little is known about the extent of these practices, or about their impact on potential homebuyers.

More basic research is needed to understand how white and minority borrowers identify potential lenders, and whether practices such as office location, referrals, or advertising make a difference. If minority access to lending opportunities is significantly constrained by these practices, then best practice agreements and fair housing enforcement efforts can and should include strategies for reaching out to more minority customers. However, without better information about how homebuyers identify potential lenders, it is difficult to know what types of remedies make sense. For example, if most borrowers are referred to their mortgage lender by their real estate agent (as part of the homebuying process), then advertising or office locations may not matter very much.

Understanding how borrowers identify potential lending institutions is also critical to the design of effective testing efforts. Paired testing, whether for research or for enforcement purposes, generally attempts to replicate a typical encounter between a consumer (homebuyer) and a producer (mortgage lender). But we do not yet know enough to be sure what a typical encounter is. In the NFHA tests, individuals posing as first-time homebuyers walked into the offices of lending institutions to inquire about loan terms and conditions. However, this may not be a typical scenario, particularly if most homebuyers are referred to lenders by the real estate agent with whom they are searching for a house.

Expand and Refine Paired Testing of Lenders

Paired testing can and should be expanded at the mortgage pre-application stage. The testing conducted by the NFHA demonstrates that paired testing is feasible, and that it uncovers instances of differential treatment that might otherwise go undetected. Because at least some lenders provide more information and assistance to white borrowers, minorities may be discouraged from submitting applications or may apply for loans with unfavorable terms. Discrimination at this stage cannot be detected through analysis of HMDA data or data drawn from lenders' application files. In fact, paired testing may be the only strategy for uncovering the incidence of discrimination at the pre-application stage. NFHA's testing (and our re-analysis of these test results) represents an important first step. But more work is needed to refine testing procedures and apply them to representative samples of lending institutions.

Paired testing can be effective for both research and enforcement purposes, although the procedures used for these two purposes are not identical. Research testing is designed to yield statistically reliable measures of the incidence (and severity) of differential treatment across a large number of transactions. Because all of the lender testing conducted to date was designed primarily for enforcement purposes, there are limits to what it can tell us in this regard. In order to learn more, the Federal Government should sponsor a paired testing effort whose primary goal is to quantify the incidence and severity of discrimination at the pre-application stage. Indeed, HUD is currently funding a pilot study which will develop several alternative paired-testing methodologies, and estimate levels of differential treatment at the pre-application stage for at least one market area.

Ultimately, such testing studies must be conducted in multiple markets, so that they can capture variation in levels and patterns of discrimination across sites. As discussed earlier, analysis of the NFHA test results suggests that there may be substantial differences between cities, and these differences need to be investigated more thoroughly. In addition, the lending institutions where tests are conducted should be selected systematically, to be representative of all lenders of a particular type or serving a particular market. For example, tests might be conducted for a random sample of lending institutions with offices in a metropolitan area, for a sample of institutions over a certain size, or for a sample of those reporting a certain number of mortgage loans.

Test reporting forms should be as tightly structured as possible, in order to permit objective comparisons of the treatment received by whites and minorities across a large number of tests. This may require advance research--or "scouting"--on the products offered and procedures followed by lending institutions in the study sites. Unless researchers and test supervisors know in advance how lending institutions treat potential borrowers prior to the formal application stage, what different loan products are called, and to whom potential borrowers might be referred, it is difficult for pairs of testers to make identical requests and to accurately record the treatment they receive. Moreover, testers should receive careful training and supervision to ensure that both members of each pair present the same attributes, qualifications, and financing needs, and that both record their treatment fully and accurately.

Finally, more thought needs to be given to the specifics of lender testing scenarios. No single test pair can explore all possible requests that potential borrowers might make at the pre-application stage or all types of lending institutions in the market. The NFHA tests paired minorities and whites posing as relatively uninformed customers who were well qualified for the types of financing about which they were inquiring. This scenario makes sense because it gives lenders the discretion to suggest different products, request different levels of information, or offer different amounts of assistance. However, other scenarios might capture different forms (and possibly different levels) of discrimination. For example, there is good reason to believe that marginally qualified whites receive more assistance and encouragement in correcting credit problems than do marginally qualified minorities. Thus, a study in which partners posed as marginally or poorly qualified borrowers might elicit different responses from lenders than a study in which testers pose as well qualified applicants. The results of research testing could prove to be extremely sensitive to the specifics of the test scenario.

At the same time that work on research testing proceeds, fair lending enforcement testing should be refined and expanded. Pre-application testing is essential for finding out if lenders are discouraging minority borrowers from ever applying, steering minorities to apply for particular loan products, or referring them to other types of lending institutions. Thus, this type of paired testing plays a critical role in the Federal Government's efforts to monitor fair lending compliance and to investigate complaints of discrimination. Fair housing organizations should be encouraged and supported in their efforts to conduct rigorous pre-application testing, both in response to complaints and to assess the extent to which differential treatment may be going undetected in the communities they serve. Moreover, lenders should be encouraged to conduct "self-testing," as a way to monitor the performance of their own operations. Experimentation with different testing scenarios should be encouraged, to reflect different classes of potential borrowers, different segments of the lending industry, and different types of pre-application requests.

Testing should not be ruled out as a strategy for investigating and measuring discrimination beyond the pre-application stage. As discussed earlier in this report, paired testing appears to be the only research methodology that would disentangle differential treatment discrimination from disparate impact discrimination at the loan approval stage. Federal law makes it illegal to provide false information on a credit application, and many people believe that this precludes full application testing of mortgage lending institutions. However, some testing advocates argue that submitting false information as part of a paired test--when the tester does not actually intend to borrow money or incur any other financial obligation--does not violate this law. So it is possible that some organizations may be willing to incur the risk of conducting paired testing beyond the pre-application stage, or that the Federal Government could issue guidance that would allow and encourage greater use of testing. Moreover, it may be feasible to design a paired testing study using the actual income and credit characteristics of testers, although the challenge involved in recruiting equally matched testers would be substantial.

Some researchers have also argued for the use of non-paired testing of mortgage lending decisions. This would involve finding a pool of actual candidates for mortgage loans. The applicants would then file genuine loan applications and the progress that they made through the loan application and approval process would be monitored and documented. Analysis would then focus on differential treatment of applicants from differing racial and ethnic backgrounds in loan approvals and, in the case of approved loans, in the loan amount, interest rates, maturity, loan type and collateral. Non-paired testing could provide definitive estimates of the overall incidence of discrimination in loan approvals, but only paired testing can reliably distinguish differential treatment discrimination from disparate impact discrimination.

Conduct a Rigorous Statistical Analysis of Mortgage Approvals Nationwide

The Boston Fed methodology should be replicated for more cities and enhanced to respond to the critical methodological issues discussed in this report. The Boston Fed Study constitutes the strongest and most complete analysis of discrimination at the loan approval stage. By assembling data on applicant characteristics and credit histories, it enabled researchers to estimate the extent to which minorities are more likely to be denied a mortgage loan, other things being equal. Despite the unprecedented scrutiny and criticism to which this study has been subjected, our re-analysis shows that it clearly disputes claims that blacks and whites receive equal treatment from the lending industry. However, this study is not able to distinguish differential treatment discrimination from disparate impact discrimination. And it cannot completely eliminate the possibility that high denial rates for minorities result from differences in their ability to meet legitimate underwriting criteria--criteria that meet the business necessity test. Moreover, the Boston Fed Study applies to only one urban area at one point in time. Comparable analysis for a representative sample of market areas is needed to assess the persistence of discrimination over time and across markets.

A multi-site study of discrimination in loan approvals should build upon the intensive review and criticism generated by the Boston Fed Study. In particular, a national study should invest significant time and attention in the collection and verification of complete and accurate data on borrower characteristics, loan characteristics, property characteristics, and credit history to guard against omitted variables and data errors that may bias results. Because of widespread differences between whites and minorities in income, wealth, property values, and credit histories, analysis which fails to account fully for these factors may seriously overstate the extent of discrimination in mortgage loan approvals. Moreover, future analysis should explore alternative versions of a loan approval model, and test extensively for possible inter-relationships among explanatory variables in order to generate unbiased results.

In order to test the hypothesis that high rejection rates for minorities are entirely due to legitimate underwriting criteria, researchers need to assemble and analyze data on loan performance and defaults as well as information on loan applications and originations. As discussed earlier, evidence of higher default rates among minority borrowers than among whites does not prove the absence of discrimination at the loan approval stage. However, analysis of loan defaults does have an important role to play in the analysis of possible disparate impact discrimination. Specifically, underwriting policies and practices that disproportionately affect minorities even when they are even-handedly applied are discriminatory under the law if they do not serve a business necessity. Thus, if an underwriting criterion or requirement systematically disqualifies more minorities than whites, but does not reliably predict future loan performance, it is discriminatory. In fact, even if a criterion did predict future loan performance, it might be considered discriminatory if it could be replaced by an alternative criterion that had less of a disproportionate adverse effect on minorities. Data on underwriting criteria and loan terms, borrower and property characteristics, and long-term loan performance all need to be linked to support definitive analysis of disparate impacts in home mortgage lending.

Finally, statistical analysis of discrimination in the loan approval process should attempt to distinguish discrimination based on the borrower's race or ethnicity from discrimination based on the racial or ethnic composition of the neighborhood in which a property is located. The existing empirical evidence on redlining (discrimination based on neighborhood composition) remains inconclusive. It may prove difficult to disentangle the effects of applicant race and neighborhood race, because most blacks currently live in black neighborhoods while most whites live in white neighborhoods. Nevertheless, the distinction is an important one from a policy perspective.

Design and Conduct Research on Loan Terms and Conditions

To date, relatively little statistical analysis has focused on the potential for discrimination in loan terms and conditions. Fair housing complaints often involve unfair terms and conditions for mortgage loans, and there are some indications that the lending industry is in the process of shifting from credit rationing to risk-based pricing. In other words, lenders may be more likely to charge higher interest rates and/or fees for customers who they perceive to be risky, rather than denying them financing altogether. Thus, it will be increasingly important to understand how interest rates and fees are determined, and to analyze the potential for either differential treatment or disparate impact discrimination in this area.

This issue is closely related to questions about credit-scoring. Both risk-based pricing and credit scoring schemes rely on data (or assumptions) about how the specific characteristics of borrowers relate to loan performance. More specifically, these schemes predict--or "score"--the risk associated with a particular borrower, based on past experience. Proponents of these systems argue that they can expand minority access by removing "human bias" from the decision-making process. Skeptics of risk-based pricing and credit scoring argue that the experience from which these predictive models are based may not be sufficiently diverse to reflect the favorable performance of loans to minorities, and that the variables used in these models may put minorities at an unfair disadvantage. Rigorous, objective analysis of the relationship between various borrower characteristics and loan performance is critically needed. Otherwise, these schemes may simply institutionalize disparate impact discrimination by imposing rules that put minorities at a disadvantage but that do not serve any business necessity.

In addition, researchers need to systematically investigate the uses of risk-based pricing and credit-scoring schemes, analyzing the criteria and procedures lenders use to determine interest rates and fees for individual borrowers. This type of research should be used to develop methods for analyzing the potential for either differential treatment or disparate impact discrimination. As several existing studies point out, it is not sufficient simply to compare the final interest rates charged to different groups. Instead, analysis should compare final interest rates to the rates originally quoted when borrowers first inquired. And researchers should attempt to collect and analyze information on various loan fees, again exploring differences between "advertised" and "actual" fees.

Further Evaluate "Best Practices" for Remedying Discrimination

In order to achieve significant reductions in mortgage lending discrimination, regulatory agencies must do a better job of identifying institutions that are discriminating. But in addition, both regulators and lenders need to know what it takes to eliminate discriminatory practices. To the extent that discrimination is blatant and intentional, designing corrective remedies may be relatively straightforward. But much of the evidence summarized here suggests that lending institutions may be discriminating without realizing it, through policies and procedures that have a disparate impact on minority borrowers, through subtle differences in the level of encouragement and assistance provided to whites and minorities, or through unexamined assumptions about the types of products and terms for which minorities can qualify. Lending institutions may believe that their practices and decisions have been "color-blind," and the institutional changes they need to make to eliminate discrimination may not be obvious.

Fair lending advocates and industry experts have identified a set of strategies that lending institutions should implement in order to comply with anti-discrimination laws. Although these "best practices" appear logical and worthwhile, their effectiveness has not been systematically evaluated. Currently, there is a tendency to identify lending institutions as "high performers" if they are implementing a widely accepted set of best practices, not because they have eliminated unequal treatment of minorities. In other words, researchers need to compare fair lending performance for institutions with and without these best practices, or for institutions implementing different remedial strategies. The goal of this research is to test to efficacy of various remedies and institutional reforms that lenders implement.

Finally, lending institutions need tools they can use to monitor and assess their own anti-discrimination efforts. The "stick" of litigation or regulatory action obviously creates an important incentive for lenders to care about the potential for discrimination in their policies and procedures. But lenders cannot take action if they do not realize that they are discriminating, and neither regulators nor fair housing groups have sufficient resources to investigate all lending institutions. Self-testing is one strategy lenders can and should use to monitor their performance, and identify any problems that may exist. Research efforts should refine and promote practical methods for lenders to monitor and assess their own performance could help advance the cause of equal access to mortgage loans for minority homebuyers.

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Content Archived: January 20, 2009