What We Know About Mortgage
Lending Discrimination In America
A Look at the Process from a Lender's Perspective
It is intriguing that neither the Decatur Federal Savings and Loan nor
Boston-area mortgage lenders apparently believed that discrimination would be
found in the investigations of their practices. If they had, they might not have
cooperated so fully, in the first case with the Justice Department and in the
second case with the Boston Fed survey. But the evidence reviewed here strongly
suggests that their belief that they were not discriminating was false. Is it
possible that lenders discriminate unknowingly? Can discrimination occur in the
mortgage lending process even when people believe they are treating all
applicants fairly? The answer to this question is vitally important in the quest
for strategies to eliminate discrimination in home mortgage lending.
In an effort to shed some light on the issue, this project assembled a site
visit team and conducted in-depth, structured interviews about the mortgage
lending process to determine what role employees played in decision making,
whether they were aware of fair lending requirements, how they perceived fair
lending issues, and how they were monitored by their company for fair lending
compliance. After the interviews, the impressions of our site-visit team were
compared with standard HMDA indicators of the lender's fair housing
performance.
Profile of a Mortgage Lender
The lender in question is a mortgage company, fully owned by a builder who
develops housing for low- and moderate- as well as middle- and upper-income
households. The lending institution has 31 employees and currently originates
mortgages worth about $70 million a year. Its loans are almost all for home
purchases rather than refinancing, and it processes more minority applications
than the average for its metropolitan area. The loan origination staff includes
six loan counselors responsible for meeting with prospective customers and
taking applications, and four loan processors responsible for collecting the
documentation needed to complete the applications. The branch manager of the
company supervises both these groups. The company also has an underwriter who is
responsible for assessing completed applications for government-insured loans
(conventional loans are underwritten by an outside firm). The branch manager and
the underwriter both report directly to the company's president.
The case-study lender posts a description of fair lending laws in its office
and has a one-paragraph fair lending statement, written by the president, in its
procedures manual. This statement describes the company's mission as
extending credit to all qualified borrowers. Two of the six loan counselors
currently on staff are Hispanic; none are African American. When new loan
counselors are hired, they receive an orientation session and extensive
on-the-job training. But none of these training procedures explicitly addresses
fair lending issues or requirements. All new employees receive a copy of the
fair lending statement in their procedures manual. Most said they had not read
it.
The research team was impressed by the high level of personal satisfaction
that the lender's staff received from their jobs. All of the staff members
who were interviewed expressed great pride in their ability to work with
borrowers who have problematic loan applications. Staff said they frequently
originate loans to applicants who may at first appear to fail a number of
underwriting guidelines, and expressed great satisfaction from helping people
achieve the dream of homeownership. All of the lender's staff expressed a
strong commitment to fair lending, which they defined as treating everybody the
same. Staff also expressed admiration and respect for the institution's
president; according to one respondent, "She is my role
model."
The Lender's Origination Process
Exhibit 3 outlines the mortgage review process implemented by our case study
lender. Because most applicants already have a purchase contract on a house
built by the owner of the mortgage company, all respondents said that they have
a strong incentive to originate as many mortgages as possible, irrespective of
race or ethnicity. As a result, there are no pre-qualification assessments.
Every customer completes a hard-copy loan application, and the information from
this application is then entered into an electronic version of the form. The
mandatory information on race is only entered on the electronic form, in an area
that is not visible on the initial computer screen. None of the loan counselors
ever predicts the outcome of the application review process for the customer.
Once a customer leaves, the loan counselor adds comments to the
computer-version of the loan application. None of the respondents said it was
acceptable to enter subjective "feelings" about an applicant. Instead,
comments are factual in nature and relate to the applicant's employment
history, credit history, income and whether the loan is government-insured or
conventional. Because these comments are entered on the electronic version of
the application, they are accessible to everybody in the company and provide
information to the underwriter and branch manager about any issues that warrant
attention. The rest of the origination process includes multiple reviews, so
that no single employee can unilaterally make a decision about any loan
application. The status of every pending loan application is discussed at weekly
staff meetings, which are attended by the loan counselor, the processors, and
the branch manager. An applicant who meets all the underwriting guidelines will
receive a mortgage subject only to the receipt of an appraisal report. Borrowers
who fail some underwriting guidelines have to comply with specified conditions.
Even very complex and hard-to-fulfill conditions do not preclude an applicant
from receiving a mortgage from the lender, however. In fact, the lender
sometimes originates mortgages to applicants a full year after the application
was initially processed. Many staff members
Exhibit 3. Lender's Origination Process
said the company originates a lot of loans to applicants who would not have
received mortgages from other companies where staff are less dedicated to
working with marginal borrowers. Most of the time, the branch manager sends
applications directly to the underwriters for review. Applications that fail
more than one underwriting guideline are sent directly to the president of the
company. No application is denied without having been personally reviewed by the
underwriter and the president (who together constitute a "loan
committee").
The underwriter does not use an automated underwriting system, nor does she
use credit scores. Rather, she judges each application by evaluating all the
relevant information in the file, without considering race or ethnicity,
according to her responses to us. She does not receive any information about the
race of the people who receive loans, and could only provide a guess as to the
percentage of minorities who receive loans from the company. She did show us
some of the letters submitted by applicants explaining past instances of
derogatory credit, however, to illustrate the types of credit problems she had
to evaluate in making her underwriting decisions. Some of these were handwritten
and we asked her who sends those: "Mainly the minorities," was the
answer. She added that poorly written credit letters did not invalidate an
applicants' reason for a derogatory credit episode.
The loan counselors and processors all receive base salaries along with a
small commission (10 basis points per loan) on the dollar volume of loans they
help process. Because commissions are small relative to base salaries, this
payment structure does not appear to create disincentives for employees to work
on small loans or applications that take extensive time to process. Moreover,
every loan counselor is assigned to a mix of housing developments, including
some targeted to lower- and moderate-income homebuyers and some targeted to
middle- and upper-income buyers.
Potential for Discrimination
Over the course of a two-day site visit, the research team scrutinized the
process used to assess applications, and was favorably impressed by the
combination of a highly transparent review process, a strong commitment to
qualifying marginal applicants, and the genuine belief by all staff that their
process is color-blind. The team's strong expectation was that the
lender's HMDA data would show a relatively small denial disparity between
white and minority applicants. But that did not turn out to be the case.
The lender's denial rate for minorities is lower than average for its
metropolitan area, indicating that it does a good job of qualifying marginal
minority applicants (and/or attracts minority applicants with above-average
qualifications). But disparities between its denial rates for whites and for
minorities are high, compared to metro-area averages (see Exhibit 4). Overall,
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the lender denies loan applications from blacks 28 percent of the time,
compared to only 10 percent for whites. Thus, the white-black denial disparity
for this lender is 28/10 or 2.8. On average, lenders in the metro area as a
whole deny 39 percent of black applications and 25 percent of white
applications, yielding a white-black denial disparity of only 1.6. In other
words, the case-study lender's denial disparity rate is almost twice as
high as the average rate for lenders in the same metro area. The same pattern
holds when denial disparities are broken down by income categories. For example,
among moderate-income applicants, the lender's loan denial rate was 2.7
times as high for blacks as for whites, compared to an area average of 1.1. For
middle-income applicants, the lender's loan denial rate was 3.1 times as
high for blacks as for whites, compared to an area average of 1.2. Relative
disparities for Hispanic applicants were on the same orders of magnitude.
Because so many of its customers have less-than-spotless credit and few
resources for a downpayment, most of the lender's originations are for
government-insured loans. Further, these are the only loans that go to the
firm's underwriter, while conventional loan applications are sent to a
third-party underwriter. Therefore, we dropped conventional loan applications
from the denial disparity comparison to get a better idea of how the firm did in
its primary loan area. The case-study lender's denial rates still showed
significant racial disparities. Income-adjusted averages reveal that the
lender's denial rates for government-insured loans are consistently higher
than the area averages for black and Hispanic applicants and lower for white
applicants.
How can we reconcile these disparities with the lender's strong belief
that its loan origination process contains absolutely no discriminatory
treatment of minority borrowers? There are three possible explanations:
- A large share of the lender's minority loan applicants may
actually be poor credit risks. It is possible that because the
case-study lender serves more minority customers than other area
lenders, these customers may be less creditworthy--on
average--than minority loan applicants in the metro area as a
whole. If so, the case-study lender's high denial disparities
(relative to metro-wide averages) may reflect the diversity of its
customer base rather than the possibility of discrimination. However,
this explanation seems inconsistent with the evidence that the case
study lender approves a larger share of applications (from both
minorities and whites) than the average for mortgage lenders metro
wide.
- The case-study lender may be applying underwriting standards that
have a disparate impact on minority borrowers. In other words, minority
customers may be denied at relatively high rates because some of the
underwriting standards applied by the case study lender have a
disproportionate effect on minorities, and do not serve a clear
business necessity. This explanation seems inconsistent with the fact
that denial disparities between whites and minorities are significantly
lower among other lenders in the metropolitan area.
- The lender's staff may be providing preferential treatment to
white customers without realizing it. Our case study indicates that loan
counselors work hard with customers to overcome problems in their
applications. It is possible that the counselors are more at ease with
white customers than with minorities, find it easier to communicate and
sympathize, or feel more comfortable spending time with whites to solve
credit problems. If this is the case, then minorities would be at a
disadvantage, not because they were treated badly but because whites
were treated better.
Given the information currently available, it is impossible to determine with
certainty which of these explanations is correct. It is clear, however, that
despite the commitment and good intentions of the case-study lender, denial
rates for minority loan applicants are unusually high, relative to denial rates
for white customers. And these denial disparities appear to be out of line with
comparable ratios for the metropolitan market as a whole.
Improving Fair Lending Performance
Lending industry experts and fair housing advocates have identified a number
of practices and procedures that lenders should implement to reduce the
possibility of discrimination against minority applicants. Our case study
reveals that the lender we visited has not fully implemented any of these fair
lending best practices. Moreover, the research literature on organizational
change contains clear lessons about "what it takes" to effectively
change behavior within an institution. Taken together, the literature on fair
lending best practices and the literature on organizational change suggest seven
recommendations for the case study lender:
- Find out whether a problem exists
. Before implementing any
institutional changes, management and front-line workers must understand
whether they have a real problem. There is a "chicken and egg"
problem concerning the data gathering needed to determine whether a
lender discriminates. To the extent that the lender does not believe it
has a problem, there is no incentive to gather more data. In addition,
organizations may face real disincentives to gather data on potential
discrimination which might be subpoenaed or otherwise disclosed.
However, without detailed information, it is impossible to determine
whether discrimination may be occurring. Given the high denial
disparities revealed by HMDA measures, the case study lender should
conduct a careful file review (comparing outcomes for white and minority
applications that had similar credit problems), and conduct paired tests
of its own operations.
- Make the case for change
. If there is a problem with
discrimination, management must explain why change is fundamental to
business success. If fair lending changes are implemented without a
clear "business case," employees are likely to perceive them
as "tacked on" to otherwise profit-oriented operations for
"feel-good" reasons. Under these circumstances, employees may
believe that the changes being implemented will actually hurt
bottom-line performance, and that they will not last very long or be
taken seriously. Unless all employees see fair lending as critical to
business success, institutional changes are unlikely to take
root.
- Create an integrated plan
. A recurring theme in the
literature on organizational change is the importance of creating a
coherent strategy, where various management policies mutually reinforce
each other. In other words, it is not sufficient to simply implement a
training program or new incentive systems without examining how these
changes interact with other policies, procedures, and incentives within
the institution. Front-line employees should be included in the
development of an integrated plan, because they often have good ideas
about how different organizational policies contradict one another in
practice. The plan should also include feed-back loops, which provide
employees with data on their performance, and reward them as performance
improves.
- Implement clear incentives
. Efforts to promote fair lending
within an institution are likely to run up against numerous barriers.
Loan counselors may have to spend more time working with small or
problematic loan applications in order to ensure equal treatment of
minorities. Many lenders--including the case study
lender--provide compensation based on the dollar value of loans
originated. This aligns incentives with the lender's financial
costs and benefits, but may not be consistent with fair lending
outcomes.
- Change decision-making procedures.
Fair lending efforts
often involve a "second look" and other extra reviews for
marginal mortgage applications, especially those of minorities. These
reviews can be helpful if marginally qualified minority applications are
receiving less attention and assistance than marginally qualified
applications from whites. However, multiple reviews can create
resentment among front-line staff who may feel that their discretion and
decision-making authority has been reduced, and that fair lending is
largely a matter of oppressive oversight by outsiders. Ideally,
front-line employees could receive frequent feedback on their fair
lending performance (along with clear incentives to provide equal
treatment), so that they feel empowered to identify problems and find
solutions.
- Provide fair lending and diversity training
. Employees at
all levels may need to gain a better understanding of the forms
discrimination can take and the importance of eliminating both
differential treatment and disparate impact discrimination. Training
should not be presented in terms of fair lending for its own sake, but
in terms of satisfying the needs of a diverse customer base as well as
complying with existing laws. Programs that promote fair lending from a
legalistic or "do-gooder" perspective are less likely to have
a lasting impact than those that emphasize the economic rationale for
effectively working with a diverse clientele.
- Recruit and retain a diverse workforce
. A lender may be able
to foster fair lending by creating a racially and ethnically diverse
workforce. It is possible that minority borrowers feel more welcome or
comfortable in an office that includes staff of their race or ethnicity.
And in some cases, having bilingual staff available may be critical.
Moreover, minority staff members may contribute new perspectives to
ongoing fair lending efforts.
Institutional change does not happen overnight. Our case study illustrates
how a lending institution might be discriminating against minorities despite its
best intentions, and reflects the challenges confronting lending institutions as
they try to ensure full and fair service to both minority and white
customers.
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Content Archived: January 20, 2009