An editorial in The New York Times last month highlighted a recent study by the Center for Investigative Reporting. The report found that African-Americans and Latinos were more likely to be denied conventional mortgages than whites, even when income, loan size, and other factors were considered. Upon studying 31 million mortgage records, there was proof that Blacks, Latinos, Asian-Americans, and Native Americans were disproportionately turned away.
I’ve worked in the mortgage industry for years, and I think that most of the professionals I’ve encountered in this business are well-intentioned. At the same time, I understand and acknowledge that these racial disparities exist, and they exemplify why I’m so determined to help close the homeownership gap.
Here, I want to outline the mortgage process and show how racial disparities can exist. These disparities aren’t necessarily the products of obvious racism, but instead are due in part to the unintended consequences of poorly aligned policies and the way incentives are set up. Here are three reasons why:
1. Mortgage shopping is extremely difficult
The Consumer Finance Protection Bureau (CFPB) states that nearly half of all homebuyers don’t shop for a mortgage and 77% of people apply with just one lender. Failure to shop can have real negative implications for homebuyers. Specifically, not all lenders are right for all borrowers or all property types. As I’ve written about in the past, lending is about fit. If a home buyer goes to one lender and is denied, that doesn’t mean they won’t be approved at another lender, yet many stop their search after being denied the first time.
If financing your home is one of life’s biggest financial transactions, why don’t more people shop? The reason is that the mortgage industry has intentionally made it difficult to shop. They do so by using sales tactics to try and convince people that they don’t in fact have options. For example, lenders require borrowers to provide their social security number and do a hard credit inquiry at the pre-qualification stage, despite having the ability to avoid this with a soft credit inquiry.
2. Misaligned incentives hurt minorities more
Lenders rely on Mortgage Loan Originators (MLOs) to source people looking for mortgages. MLOs get a commission on each mortgage, typically around 1% of the loan amount. So, if you are trying to maximize your income as a Mortgage Loan Officer, it makes sense that you would target big mortgages with high-income homebuyers with perfect credit that will close without any issues.
These are referred to as “perfect deals” and they are disproportionately white. Analogously, “tough deals,” smaller mortgages with a homebuyer who may have lower income or lower credit, are held disproportionately by people of color. Consider that 64% of white borrowers in 2013 had a FICO score of 720 or greater, compared with 41%and 33% of Hispanic and African-American borrowers. This distinction typically results in MLOs competing for “perfect deals” and avoiding “tough deals”. When a homebuyer has fewer options, it usually ends with worse terms or in some cases unnecessarily being denied financing.
3. Some lenders make credit requirements artificially high
Borrowers with credit scores of 580 or higher are eligible for financing using loan programs offered through the Federal Housing Association. However, many lenders limit the credit applicants they will accept to only those with higher scores.
By focusing on loans that will make it through the lender’s system with limited issues (usually loans for people with high credit scores), lenders can increase the profitability of the loan when it’s sold on the secondary market. Most banks sell your mortgage on the secondary market after you close your loan, so they will try to accumulate loans with higher credit scores, while those with lesser credit scores suffer from limited options, despite the federal minimum requirements.
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Racial bias in the mortgage industry is a very real, serious, and concerning problem. As The New York Times points out in its column, the disparity in mortgage access disrupts a prime opportunity for families of color to accumulate wealth. Here are my thoughts on three ways we can fix this:
1. Eliminate barriers to mortgage shopping and fully anonymize it
We should break down barriers to shopping. Borrowers deserve options and we should make it easier for them to find the lender that is best for them. Moreover, every lender should decide to present offers to applicants without knowing details that could lead to bias, like the applicant’s race, gender, or even their name (because even a name can lead to assumptions). The decision to make an offer should be based on the borrower’s credit profile and the property information, and nothing else.
2. Full disclosure of MLO’s commissions
The commission paid to the Mortgage Loan Originator is typically the fee that has the biggest impact on the rate that a borrower receives, yet it’s never disclosed to the consumer. This is not right. The commission paid to an MLO should be disclosed to the borrower in the Loan Estimate and Closing Disclosure. This won’t totally eliminate racial bias directly, but it will bring more transparency to the transaction for all consumers and it would lead to a more consistent commission rate, which would benefit borrowers of all races.
3. Increased public-private partnerships
MassHousing and the Boston Home Center are examples of local programs that are doing great work to promote fair housing. For example, MassHousing just announced its zero down-payment program. These types of programs help lenders and real estate agents get deals done for folks who have less than perfect credit scores and might not be able to provide a 20% down payment.
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We are a small piece of the puzzle, but for us at RateGravity, we are trying to do our part. Specifically, we partner with multiple lenders to provide our customers with an array of options from banks, credit unions and mortgage companies. This helps us to find the optimal lender for each borrower and allows borrowers to shop without any obligation. To ensure fairness, we get paid the same fee by every lender on every transaction, no matter what. That means we don’t have incentives to charge people higher interest rates. And, when we present a customer’s profile to our lenders for them to make an offer, it’s anonymous. The lender knows nothing about the customer’s race, gender, or ethnicity. The offer is based on the merits of the credit profile, which is very rare in this industry. Lastly, we only work with local lenders who understand and embrace our transparent, anonymous process that’s designed to create a system that’s fairer for everybody.
The White median family net worth is nearly 10 times that of African-American families. And when families of color face barriers to homeownership, and as neighborhoods rapidly gentrify, many minority families are being forced out of communities they’ve lived in for decades. The mortgage industry bears some of the responsibility for that gap. By changing the way we do business, the mortgage industry can do its part to close the racial divide, ease an ever-growing rift between racial groups, and move us toward a more harmonious society.