Minority mortgage market experiences leading up to and during the financial crisis

Stephen Ross

The foreclosure crisis that followed the subprime crisis has had significant negative consequences for minority homeowners. This column reviews recent evidence in the racial and ethnic differences in high cost loans and in loan performance. Minority homeowners, especially black homebuyers, faced higher price of mortgage credit and had worse credit market outcomes during the crisis. This is largely due to the fact that minority borrowers are especially vulnerable to the economic downturn.

The foreclosure crisis and the growth of subprime lending that preceded the crisis have disproportionately affected low income and minority neighbourhoods (Geradi and Willen 2009, Fisher et al. 2010, Mayer and Pence 2007, Edminston 2009) and have had significant negative consequences for minority homeownership (Geradi and Willen 2009). Some papers have suggested that subprime lending played a substantial and general role in the foreclosure crisis (Mian and Sufi 2009), and others have argued that high cost lending in minority neighbourhoods contributed to the high foreclosure rates among blacks and Hispanic borrowers (Reid and Laderman 2008). Bhutta and Canner (2013) find a lower incidence of high cost loans within banks' Community Reinvestment Act (CRA) assessment areas, possibly consistent with mortgage brokers playing a role in high cost lending. Further, discrimination in the underwriting of prime mortgages (Munnell et al. 1996, Ross and Yinger 2000) may cause minority borrowers to select into the subprime market. In fact, the US Department of Justice has recently filed several cases against major lenders for steering minority borrowers into subprime loans.

At the same time, the purpose of subprime lending was to provide credit to borrowers who faced credit constraints in the primary mortgage market, and such borrowers would be expected to face a higher price of credit and have worse credit market outcomes. African-Americans and Hispanics have lower levels of wealth (Charles and Hurst 2002, Herbert et al. 2005), and as a result are likely to face significant downpayment constraints that create barriers to homeownership (Deng et al. 2003, Gyourko et al. 1999, Duca and Rosenthal 1994). Further, minority mortgage applicants tend to have, on average, lower credit quality and incomes, as well as higher loan to value ratios than white borrowers (Ross and Yinger 2000, Bhutta and Canner 2013). In fact, many studies of loan pricing at the individual lender level find at most modest and often zero racial and ethnic differences in prices (Black et al. 2003, Courshane 2007, Courshane and Nickerson 1997).

However, very few studies assess market wide racial and ethnic differences in either the price of credit or credit market outcomes, such as mortgage delinquency or foreclosure. Several studies use proprietary samples to examine the outcomes of minority borrowers. On the price of credit, Reid and Laderman (2009) find substantial racial and ethnic differences in the likelihood of receiving a high cost or rate spread loan, and find that the wholesale origination channel plays a major role in explaining the incidence of high cost loans for all demographic groups. Haughwout et al. (2009) find no racial differences in the price of credit for 2/28 mortgages in 2005, while Ghent et al. (2013) find racial and ethnic differences for longer term adjustable rate mortgages with those differences being concentrated in the purchase market and among non-depository lenders. Further, Reid and Laderman (2009) find substantial racial differences in the likelihood of default among loans to African-Americans and Hispanics. One key limitation of these papers is that the samples tend to be dominated by privately securitised loans and so composed primarily of non-conforming loans originated in what is thought of as the subprime mortgage market.

Racial and ethnic differences in high cost loans

One recent paper (Bayer et al. 2014) examines racial and ethnic differences in the incidence of high costs loans in a sample that provides broad coverage of the mortgage market during the period leading up to and into the crisis. They draw samples of home purchase and refinance loans in seven major metropolitan areas between 2004 and 2008 from the Home Mortgage Disclosure Act data. They merge this data with detailed assessor, transaction and lien data in order to obtain information on the housing price, the combined loan to value ratio and the type of mortgage, e.g. adjustable or fixed rate, plus the address, and then provide these addresses to a major credit repository in order to obtain anonymous loan files with detailed credit history information.

• Using the resulting sample, they estimate models on the likelihood of obtaining a high cost or rate spread loan using detail controls for mortgage risk factors and find that both blacks and Hispanic are more likely to have high cost loans for both home purchase and refinance loans across all metropolitan markets.

Further, a majority of the observed differences are associated with the lender as opposed to resulting from differences in the price between equivalent white and minority borrowers at the same lender. For blacks in the home purchase market, the racial differences are spread across the entire market, rather than being concentrated among loans with credit risk factors that are typically associated with subprime lending. For Hispanic homebuyers, differences are concentrated among borrowers with high loan to value ratios and subprime credit scores. Finally, they find that the racial differences in high cost loans are associated with locations where most black borrowers have relatively low levels of education, suggesting a potential role for financial sophistication in explaining the high incidence of high cost loans among black borrowers.

Minority differences in loan performance

In a companion paper using the same sample, Bayer et al. (2012) examine racial and ethnic differences in loan performance. They examine the likelihood of mortgage delinquency and foreclosure from 2005 to 2009 for mortgages underwritten between 2004 and 2008.

• They find substantial racial and ethnic differences in the likelihood of delinquency and foreclosure, even after controlling for credit risk factors and for contemporaneous estimates of negative equity and county wide risk of unemployment.

Racial differences in unemployment risk can explain part of the differences for black homebuyers, and the remaining differences appear to be concentrated among borrowers who have very high debt to income ratios. On the other hand for Hispanics, ethnic differences in county employment rates cannot explain the observed differences, but the delinquency and foreclosure differences are concentrated almost entirely in counties with the highest overall unemployment rates for Hispanics. Further, the unexplained racial and ethnic differences are concentrated among individuals who purchased their homes near the peak of the housing and mortgage market expansion, and these effects are largest among borrowers with high debt to income ratios and who have been exposed to low employment rates. Bayer et al. argue that this evidence is consistent with a process where borrowers sort into homeownership in part based on their expected risk of adverse future events. As credit becomes more easily available, the new entrants to the housing market will tend to be those who face the highest risks of negative outcomes during an economic downturn, and these effects are felt most dramatically among minority borrowers who in general tend to be more vulnerable to economic downturns (Hoynes et al. 2012).

Concluding remarks

Minority homebuyers, especially black homebuyers, tend to face a higher cost of mortgage credit and had substantially worse credit market outcomes during the recent downturn than white homebuyers with equivalent mortgage risk factors. In terms of the price of credit, a majority of the unexplained differences are associated with the lender from which the homebuyer obtained credit. These effects are felt most among minority borrowers with the lowest levels of education, and are likely due in part to the concentrated activity of subprime lenders in minority neighbourhoods and a lack of knowledge of financial markets among minority borrowers with low levels of education. On the other hand, most of the racial differences in loan performance that are unexplained by traditional credit risk factors cannot be captured by controlling for either the lender or other aspects of subprime lending. African-Americans and Hispanics appear to be much more vulnerable to an economic downturn and to the associated risks of unemployment and housing price declines than observationally similar white homeowners. This higher vulnerability is most pronounced for borrowers who purchased their homes right before the onset of the financial crisis, even after controlling for the increased risk of negative equity associated with buying at the peak of the market. While the expansion of the subprime sector may have contributed to a higher cost of credit for black homebuyers, the concentration of black homebuyers in high cost loans and in the subprime market more generally can explain only a small portion of the racial differences in foreclosure. Rather, a broad spectrum of Black and Hispanic borrowers appears to be especially vulnerable to the economic downturn and associated shocks to their ability to meet their mortgage commitments.

References:

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Bayer, P, F Ferriera and S L Ross (2014), “Race, Ethnicity and High Cost Mortgage Lending: Borrower Experiences Leading up to the Crisis”, Working Paper.

Bayer, P, F Ferriera and S L Ross (2012), “The Vulnerability of Minority Homeowners in the Housing Boom and Bust”, NBER Working Paper #19020.

Bhutta, N and G B Canner (2013), “Mortgage Market Conditions and Borrower Outcomes: Evidence from the 2012 HMDA Data and Matched HMDA--Credit Record Data”, Federal Reserve Bulletin, 99.

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