What We Know About Mortgage
Lending Discrimination In America

Introduction

A major element of the American dream is a home of one's own in the neighborhood of one's choice. Owning a home is one of the primary ways of accumulating wealth in our society, a form of wealth acquisition that is especially protected in the U.S. tax code. Being a homeowner is also known to increase people's feelings of control over their lives and their sense of overall well-being. High rates of homeownership are believed to strengthen neighborhoods as well, by increasing residents' stake in the future of their communities.

But not all Americans enjoy equal access to the benefits of homeownership. Federal law prohibits discrimination in the home buying process, mandating that all would-be home buyers must be treated equally by real estate agents, lenders, appraisers, and insurance brokers. However, existing enforcement mechanisms may not be sufficient to guarantee equal treatment or equitable results. Indeed, research clearly shows that minorities still face substantial discrimination in the process of looking for a home to buy (or rent).

Many people believe that minorities also face discrimination when they try to obtain a mortgage-a necessity for most Americans wanting to buy a home. There is no question that minorities are less likely than whites to obtain mortgage financing and, if successful, receive less generous loan amounts and terms. But whether these differences are the result of discrimination-rather than the inevitable result of objectively lower creditworthiness-is still debated in some quarters. The problem here is not that analysts or practitioners have ignored the question of discrimination in mortgage lending. Many research and investigative studies have addressed certain facets of it, using different data sets and analytic techniques to study various outcomes. The problem is that these studies have not produced a clear consensus on a set of conclusions.

The purpose of this report is to sort through the research evidence on mortgage lending discrimination, in order to 1) provide policy makers with a comprehensive and comprehensible review of the current state of knowledge on lending discrimination, 2) add new evidence and insight by looking at the mortgage application process from a lender's perspective; and 3) identify important questions that still need to be answered in order to recommend how best to further the goal of fair housing for all. This report draws upon a comprehensive review and re-analysis of existing evidence regarding discrimination by mortgage lenders, commissioned by the United States Department of Housing and Urban Development and conducted by the Urban Institute. It provides an up-to-date summary of what we know-and what we need to know-about mortgage lending discrimination.

Our review of the existing research evidence concludes that minority homebuyers in the United States do face discrimination from mortgage lending institutions. Discrimination in home mortgage lending takes two forms-differential treatment and disparate impact-and in many instances, it is difficult, if not impossible to disentangle the two. Although significant gaps remain in what we know, a substantial body of objective and credible statistical evidence strongly indicates that discrimination persists:

FINDING #1. Discrimination can begin at the early stages of the mortgage lending process, including pre-application inquiries by would-be borrowers. This analysis reviewed results from HUD-funded "paired testing" that was carried out in selected cities. Testers of different races, who were matched on credit history and other traits, approached lenders with the same types of mortgage needs. Overall, minorities were less likely to receive information about loan products, received less time and information from loan officers, and were quoted higher interest rates in most of the cities where tests were conducted.

FINDING #2. At later stages of the process, racial disparities in loan denial rates cannot be "explained away" by differences in creditworthiness or by technical factors affecting the analyses. Statistical re-analysis of data assembled by the Federal Reserve Bank of Boston (data that include measures of creditworthiness and other important factors) finds large differences in loan denial rates between minority and white applicants, and these differences cannot be explained away by data or statistical problems asserted by prior critics of the "Boston Fed" study. This analysis presents substantial evidence that discrimination exists, shifting the "burden of proof" to those who would argue that these differences are entirely due to racially neutral underwriting criteria.

FINDING #3. Good intentions-on the part of lenders-are not enough.
In-depth examination of the mortgage loan origination process from an individual lender's perspective suggests that even among institutions with good intentions, and where loan officers take pride in working with borrowers who need more help on loan applications, minority customers may not be receiving equal treatment. The evidence on organizational change suggests that achieving significant reductions in lending discrimination may require such changes in business practices as: improving employee awareness of and attitudes toward fair lending obligations; making the "business case" for fair lending and its importance to the firm; implementing clear incentives that support change; monitoring employee performance on fair lending; tackling underwriting standards that have disproportionate, negative effects on minorities but serve no clear business purposes; and more.

Given the body of evidence reported here, no one can argue that more research is needed to justify aggressive monitoring and enforcement efforts. But more research is needed to refine and target enforcement strategies, to enable lending institutions to monitor their own performance so that they know whether they have a problem to address, and to design remedies to reduce discrimination in lending. Specifically, we recommend:

• Expanded research on lender decisions about office locations, advertising and outreach, and referrals that may discourage minorities from ever applying for loans with some institutions;
• stepped-up testing at the pre-application stage, and possibly the loan approval stage as well, for research, enforcement, and self-assessment (by lenders);
• replication and enhancement of the Boston Fed methodology nationwide, including systematic analysis of mortgage loan performance to determine the business necessity of lending criteria and procedures that disproportionately disadvantage minorities;
• expanded research on loan terms and conditions, including objective examination of risk-based pricing and credit-scoring formulas, as well as analysis of overages and fees; and
• serious evaluation of fair lending best practices to find out what works.

This report begins with a brief review of the issues involved in measuring the incidence and severity of lending discrimination, including different ways in which discrimination can be defined and measured and the reasons why lenders might discriminate. This is followed by assessments of the evidence on discrimination at each major stage in the mortgage lending process-in some cases including new work conducted specifically for this project. We then shift focus, looking at the mortgage application process and the potential for discrimination from a lender's perspective, in order to better understand what it will take to recognize and remedy discrimination. The report concludes by recommending priority next steps in measuring mortgage discrimination and developing policies and practices to better combat it.

Why It Is Difficult To Measure Lending Discrimination

Investigative activities by fair housing advocates and others have identified and successfully prosecuted cases of mortgage lending discrimination. However, analytic studies measuring the overall incidence of discrimination are subject to widely differing interpretations. The crux of the problem is that legal evidence of discrimination in specific cases is not the same as statistical measures of the overall level at which discrimination occurs. For analytic estimates of discrimination, researchers need to be confident that individual instances of discrimination are more than isolated occurrences, and that they add up to a consistent pattern that favors whites and outweighs in a statistical sense any corresponding pattern that favors minorities.

Two characteristics of mortgage financing make it especially difficult to reach definitive statistical estimates of discrimination. The first is that the home mortgage lending process is a complex series of stages. Discrimination could be occurring at any one or more of these, and could take different forms at different stages. But until the stages themselves are clearly distinguished, and the incidence of discrimination measured at each, its overall incidence cannot be properly interpreted. The second is that what everyone now acknowledges to have been deliberate discrimination by many institutions in American society in the past has left a legacy of economic inequality between whites and minorities that still exists today. This legacy includes racial and ethnic differences in characteristics that influence the creditworthiness of any mortgage applicant-income, accumulated wealth, property values, and credit history. Much of the current debate about mortgage lending discrimination stems from disagreement about how much of minorities' differential success in obtaining mortgage loans is due to credit-relevant factors that vary with race or ethnicity (and that may flow from the Nation's discriminatory past) and how much is due to ongoing discrimination.

Different Forms of Discrimination

Discrimination in mortgage lending can take two different forms. It is important to understand the distinctions clearly, because the different forms of discrimination may require different measurement strategies, as well as different remedies. The fundamental distinction is between differential treatment and disparate impact discrimination.

Differential treatment discrimination occurs when equally qualified individuals are treated differently due to their race or ethnicity. In mortgage lending, differential treatment might mean that minority applicants are more likely than whites to be discouraged from applying for a loan, to have their loan application rejected, or to receive unfavorable loan terms-even after taking into account characteristics of the applicant, property, and loan request that affect creditworthiness. A finding of differential treatment discrimination means that minorities receive less favorable treatment from a given lender than majority applicants with the same credit-related characteristics (as observable by the lender).

Disparate impact discrimination occurs when a lending policy, which may appear to be color-blind in the way it treats mortgage loan applicants, disqualifies a larger share of minorities than whites, but cannot be justified as a business necessity. A widely cited example is the policy of minimum mortgage loan amounts-setting a dollar limit below which a lending institution will not issue mortgages. More minorities than whites will be adversely affected by any given loan cut-off, because-on average-minorities have lower incomes than whites and can only afford less costly houses. Policies such as minimum loan amounts, which disproportionately affect minorities, are illegal unless they serve an explicit business necessity. If these policies do not accurately reflect creditworthiness, or if they could be replaced by policies serving the same business purpose with less of a disproportionate effect on minorities, then they are deemed under Federal law to be discriminatory.

The point for public policy is that policies which are discriminatory in effect may have adverse consequences of much greater magnitude than practices that treat individuals differently on the basis of their race. Federal policy makes disparate impact discrimination illegal so that institutional policies do not simply perpetuate patterns of racial inequality, many of which are the consequence of past discrimination. In other words, achieving a world of truly fair lending will require remedies that go beyond color-blindness.

Possible Motives for Discrimination

The most straightforward explanation for why discrimination occurs is prejudice (often referred to by analysts as taste-based discrimination). If lenders-or their employees-are prejudiced against minorities, they consider them to be inherently inferior and prefer not to interact with them or have them as customers. The lending industry has long argued that it does not discriminate, because doing so would go against the very reason for being in business-maximizing profits. It is not the color of a customer's skin that matters, according to an often-quoted statement of this viewpoint, but the color of his or her money. This argument does not dispose of the discrimination issue, however. First, it is entirely possible for prejudice to persist among profit-motivated businesses, due to market imperfections, information barriers, and the large number of people who participate in a loan-approval decision. In fact, suggestive, though not definitive, evidence that prejudice may indeed be a factor at work comes from one study in which black-white disparities in loan approval rates decline as minority representation in either a lender's overall workforce or its management staff increases.

Moreover, even if there is no "taste-based" discrimination in the industry, discrimination may in fact be in a mortgage lender's perceived economic self-interest. Discrimination for this type of reason is referred to as economic discrimination, to distinguish it from discrimination due to prejudice. The key point here is that some factors that influence a lender's expected rate of return may also be highly correlated with race or ethnicity. For example, minorities may be less likely than whites to have affluent family members who can help them out if they get into a financial bind, or they may be more likely to be laid off in the event of an economic downturn. If lenders think that race is a reliable proxy for factors they cannot easily observe that affect credit risk, they will have an economic incentive to discriminate against minorities. Thus, denying mortgage credit to a minority applicant on the basis of information that is valid for minorities on average-but not necessarily for the individual in question-may be economically rational. But it is still discrimination, and it is illegal.

Recent attention has focused on cultural affinity as another possible reason for discrimination. This argument attributes discrimination to the lack of affinity among white loan officers for the culture of certain minority groups. Because they feel less comfortable with minority borrowers, or because they are not able to understand the way minorities communicate, loan officers may exert less effort to determine creditworthiness or to help minority borrowers meet underwriting criteria. The literature suggests several possible explanations for why this type of behavior might be occurring, but most turn out to be forms of either prejudice or economic discrimination. Another version of the cultural affinity argument is that blacks and whites tend to sort themselves by lender-black to black, white to white-and the resulting pattern of loan offerings is discriminatory to minorities. Indeed, there is some suggestive evidence that applicants may sort themselves by race in selecting lenders, but not that this form of "cultural affinity" results in differential loan denial rates.

Potential for Discrimination Throughout the Mortgage Lending Process

Home mortgage lending is a complex process, composed of many different decision points and institutional policies. Exhibit 1 provides an overview of key stages in the process. As discussed earlier, there is a potential for discrimination to occur at any one or more points along the way. This makes research challenging, for several reasons:

• A finding of little or no discrimination at one stage in the process does not necessarily prove the absence of discrimination in the process as a whole.
• Discrimination may take different forms from one stage to the next, so that a single set of measurement techniques may not apply across the entire process.
• Discrimination at one stage may influence the characteristics and requests of potential borrowers at a subsequent stage. For example, if a lender systematically steers minorities to apply for federally insured loans, while whites are encouraged to apply for conventional loans, analysis of the loan approval decision will be complicated by the fact that minorities and whites are requesting different types of loans, regardless of their qualifications.

To date, very little research has focused on lenders' outreach, advertising, or office location decisions (the first stage in the process). And there has been almost no analysis of potential discrimination in the way loans are administered or how foreclosure decisions are made. Thus, although considerable analysis has focused on potential discrimination at the loan approval stage, the existing evidence provides an incomplete picture of the overall incidence of discrimination experienced by minority homeseekers. The next four sections of this report focus in turn on four major stages in the mortgage lending process, summarizing what we know about the levels of discrimination occurring at each.

Exhibit1: Key Stages in the Mortgage Lending Process

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Content Archived: January 20, 2009