Why Do Minorities Pay More For Mortgages?
June 19, 2006, Revised July 25, 2007
"I read about a study recently claiming that Afro-Americans and Hispanics paid more for mortgages than white borrowers who were otherwise similar. Do you believe this to be true, and if so, why does it happen, and what should be done about it?"
I have looked at the studies, including a very recent one by the Center for Responsible Lending (CRL). While most of the studies leave out important differences between the groups, including credit scores, the CRL study takes into account credit and other relevant factors, and its findings are the same. They find that minorities generally pay more, which rings true to me.
To understand how and why it happens, it is necessary to understand how mortgages prices are determined. In more than 90% of the transactions, it is a two-stage process. Stage 1 is the development of posted prices that are delivered to loan officers and mortgage brokers. Stage 2 is the determination of final prices paid by the borrower.
Posted prices are either retail or wholesale. Wholesale prices are posted by wholesale lenders to mortgage brokers and correspondent lenders (CLs). (Unlike brokers, CLs fund loans, but they deliver them to the same wholesale lenders as broker. Henceforth, I use the term "broker to include CLs). Retail prices are posted by retail lenders to their loan officer employees,
Mortgage prices, are delivered by fax or (increasingly) over the internet in the form of "price sheets’. These sheets are voluminous because each loan program must be priced separately, and because pricing has become so complex. Prices vary with the borrower’s credit, purpose of loan, type of property, type of documentation, state location of property, and other factors.
Posted prices do not vary with race, which would be blatantly illegal. Neither do prices vary with proxies for race, such as property location. Minorities are much more heavily concentrated in center cities than in suburban areas, for example, so mortgage pricing based on this distinction could be discriminatory. However, lenders do not make such distinctions in their pricing. Most lenders in their pricing use only states. Some divide large states such as California into regions, but the regions don’t correspond to any racial divisions.
The upshot is that lenders do not discriminate in their posted prices. Lenders may commit many sins, but discrimination against minorities is not one of them. I have looked at the price sheets of hundreds of lenders, both wholesale and retail. I have never seen one that had even a whiff of discriminatory treatment of minorities.
The unequal treatment of minorities occurs at the second stage, where posted prices are converted into final prices to the borrower.
In the wholesale market, lenders deliver wholesale prices to brokers, who add a markup to derive the retail prices offered to borrowers. If the posted price is 6% and zero points, for example, a broker might offer the loan at 6% and 1.5 points, the 1.5 points being the markup.
Within very wide limits, brokers have complete discretion over the final price. They are independent contractors who price as they please. Some wholesale lenders place limits on markups, but these limits are absurdly high. Since there are hundreds of wholesale lenders, and brokers move easily from one to another, any one lender attempting to enforce more rigorous constraints on markups would quickly lose brokers.
In the retail market, lenders deliver retail prices to their loan officer employees (LOs). The lender’s markup, including the LO’s commission, is already included in these prices. However, LOs have limited discretion to charge more than the posted prices "in order to take advantage of market opportunities", and to charge less "in order to meet competition." Such price deviations are termed "overages" and "underages" respectively. Overages exceed underages by a wide margin. See What is a Mortgage Overage?
The great majority of brokers and LOs are "equal-opportunity over-chargers". They charge what the market will bear, without regard to race or color. Some are no doubt prejudiced, and if they had any market power to go along with their pricing discretion, they might use it to discriminate against minorities. Because the competition for customers is so intense, however, any such attempts would cost them money.
On the other hand, there may be a perception that minorities are easier to take advantage of than whites. To the extent that this is true, a market in which loan providers at the point of sale charge as much as they can get away with affects minorities disproportionately. The result is the same as if there were deliberate discrimination.
A related explanation for why minorities pay more for their mortgages than whites, offered by CRL, is that minorities receive more of their loans than whites from high-price lenders. This would be true if high-price lenders target minorities more than whites, which would be patently illegal and which I doubt occurs.
Alternatively, high-price lenders probably do more high-powered soliciting than other lenders, and if minorities are more vulnerable to solicitations, they will end up with dealing with those lenders in disproportionate numbers. I suspect that this does indeed happen. It is why I constantly advise borrowers of every color not to respond to solicitations. I wish I heard more preaching on this subject from community groups.
Community groups don’t accept my contention that discrimination arises from discretionary pricing by loan officers and mortgage brokers at the point of sale, because it takes lenders off the hook. Brokers and loan officers are a much less attractive target for them than lenders. A recent study by the Center for Responsible Lending (CRL) concedes that posted prices are free of bias, but claims that lenders influence the final prices in indirect ways that can be discriminatory. In my opinion, none of their arguments withstand close scrutiny (see my appendix note).
Community groups also don’t like the idea that loan officers and brokers are out to skin everyone but are more successful with minorities. This conclusion can be interpreted to mean that the victims are partially responsible for their own mistreatment.
In my view, this interpretation is sometimes unavoidable. Borrowers are victimized primarily because they are ill-informed, and given that the information that would protect them is widely available, they bear some responsibility for not finding and using it.
When this article appeared in the press, I received numerous letters complaining about Hispanic loan officers and brokers who took advantage of the Hispanic borrowers who sought them out. I have not verified these reports, but it would hardly be surprising if it were true. I would expect Hispanic loan providers would be equal-opportunity over-chargers, just like their white compatriots, except that they find better pickings in the Hispanic community.
In the community group vision of the mortgage market, lenders are the villains and minorities the victims. Their proposed remedies largely involve government increasing the burdens and responsibilities imposed on lenders. For example, community groups favor making lenders legally responsible for the suitability of the mortgages they provide in meeting the needs of borrowers. I am opposed to such a rule, for reasons discussed in Mortgage Suitability.
I wish the community groups did a better job of advising their constituents about how to avoid trouble. Their advice is directed at how to identify the bad guys, which in my view is the wrong approach. There are too many bad guys, and they are too good at disguising their true nature.
The right approach is to identify the good guys and ignore the rest, the same approach used by savvy pickers of wild mushrooms. They only pick the ones they know are good. Picking the mushrooms that aren’t bad requires an ability to identify all the bad ones, which is more time-consuming and much riskier.
Minorities (and others) can avoid discrimination by selecting distribution channels where pricing discretion is either absent or controllable by the borrower. Pricing discretion is absent in internet-based lending, because loan officers don’t capture the customer and therefore don’t have the clout to dictate their terms of employment.
Internet-based lending offers other borrower protections as well. These include more complete information on lender fees and third party fees, and the ability of shoppers to monitor their price from day to day until they lock it. I certify lenders who provide all the information needed by borrowers to shop on-line as Upfront Mortgage Lenders.
Another way to avoid discrimination is to negotiate an all-in fee with a mortgage broker, the fee to include any payments received by the broker from the lender. While most brokers don’t work that way, preferring to keep their markup their own business, most of them will if the borrower insists on it. (Upfront Mortgage Brokers work this way as a matter of course). The borrower has the clout to dictate the terms of his engagement with the broker, if only he realizes it.
If the CRL and other community groups guided borrowers to lending channels where they would not be exploited, these channels could become the dominant delivery systems, and the channels where predators operate would shrink. This would require nothing of Government, whose track record in protecting mortgage borrowers is very poor.
CRL offers two explanations for why minorities pay more for their mortgages than whites. Their "market segmentation" explanation was discussed above. CRL’s "disparate pricing" explanation is that lenders charge minority borrowers more than comparable whites. They don’t accept that posted prices are free of bias.
"While rate sheets do present objective pricing schedules for calculating a loan’s interest rate, they are not definitive statements of a loan’s price for a given borrower. Discretionary yield spread premiums and other up-front charges, as well as negotiated exceptions to rate sheet guidelines are common examples of how a loan’s price can vary from prices displayed on a rate sheet." (p.20)
This argument does not hold water. Yield spread premiums are not discretionary, and rate sheet guidelines are never negotiated.
Yield spread premiums (YSPs) are another name for rebates (or negative points) paid by lenders to mortgage brokers on high rate loans, as illustrated in the table below.
YSPs are often associated with broker overcharges, because brokers may pocket them without the knowledge of borrowers. But the fact that rebates may be associated with broker abuse does not make them discretionary. The high rate/rebate combinations on the price sheet are firm offers by the lender in exactly the same way as low rate/high point combinations. Wholesale lenders are not involved in rebate abuse by brokers. It puts no money in their pockets.
Further, there are no "negotiated exceptions to rate sheet guidelines." Not all brokers get the same rate sheets, larger ones command slightly lower prices, but the individual prices on a rate sheet are never negotiated.
It is true that inquiries as to what the posted price is in a specific situation are common. The reasons are that pricing structures are extremely complex, price sheets cover only the most common programs and options, and brokers want to avoid making a costly mistake. However, inquiries are not "negotiated exceptions." The "broker reps" who deal with mortgage brokers and answer these questions, do not have authority to change the posted prices.
"I read about a study recently claiming that Afro-Americans and Hispanics paid more for mortgages than white borrowers who were otherwise similar. Do you believe this to be true, and if so, why does it happen, and what should be done about it?"
I have looked at the studies, including a very recent one by the Center for Responsible Lending (CRL). While most of the studies leave out important differences between the groups, including credit scores, the CRL study takes into account credit and other relevant factors, and its findings are the same. They find that minorities generally pay more, which rings true to me.
Mortgage Price Determination: Posted Prices
To understand how and why it happens, it is necessary to understand how mortgages prices are determined. In more than 90% of the transactions, it is a two-stage process. Stage 1 is the development of posted prices that are delivered to loan officers and mortgage brokers. Stage 2 is the determination of final prices paid by the borrower.
Posted prices are either retail or wholesale. Wholesale prices are posted by wholesale lenders to mortgage brokers and correspondent lenders (CLs). (Unlike brokers, CLs fund loans, but they deliver them to the same wholesale lenders as broker. Henceforth, I use the term "broker to include CLs). Retail prices are posted by retail lenders to their loan officer employees,
Mortgage prices, are delivered by fax or (increasingly) over the internet in the form of "price sheets’. These sheets are voluminous because each loan program must be priced separately, and because pricing has become so complex. Prices vary with the borrower’s credit, purpose of loan, type of property, type of documentation, state location of property, and other factors.
Posted Prices Are Free of Discrimination
Posted prices do not vary with race, which would be blatantly illegal. Neither do prices vary with proxies for race, such as property location. Minorities are much more heavily concentrated in center cities than in suburban areas, for example, so mortgage pricing based on this distinction could be discriminatory. However, lenders do not make such distinctions in their pricing. Most lenders in their pricing use only states. Some divide large states such as California into regions, but the regions don’t correspond to any racial divisions.
The upshot is that lenders do not discriminate in their posted prices. Lenders may commit many sins, but discrimination against minorities is not one of them. I have looked at the price sheets of hundreds of lenders, both wholesale and retail. I have never seen one that had even a whiff of discriminatory treatment of minorities.
The unequal treatment of minorities occurs at the second stage, where posted prices are converted into final prices to the borrower.
Final Prices Have a Discretionary Component
In the wholesale market, lenders deliver wholesale prices to brokers, who add a markup to derive the retail prices offered to borrowers. If the posted price is 6% and zero points, for example, a broker might offer the loan at 6% and 1.5 points, the 1.5 points being the markup.
Within very wide limits, brokers have complete discretion over the final price. They are independent contractors who price as they please. Some wholesale lenders place limits on markups, but these limits are absurdly high. Since there are hundreds of wholesale lenders, and brokers move easily from one to another, any one lender attempting to enforce more rigorous constraints on markups would quickly lose brokers.
In the retail market, lenders deliver retail prices to their loan officer employees (LOs). The lender’s markup, including the LO’s commission, is already included in these prices. However, LOs have limited discretion to charge more than the posted prices "in order to take advantage of market opportunities", and to charge less "in order to meet competition." Such price deviations are termed "overages" and "underages" respectively. Overages exceed underages by a wide margin. See What is a Mortgage Overage?
Discrimination Arises From Discretionary Pricing
The great majority of brokers and LOs are "equal-opportunity over-chargers". They charge what the market will bear, without regard to race or color. Some are no doubt prejudiced, and if they had any market power to go along with their pricing discretion, they might use it to discriminate against minorities. Because the competition for customers is so intense, however, any such attempts would cost them money.
On the other hand, there may be a perception that minorities are easier to take advantage of than whites. To the extent that this is true, a market in which loan providers at the point of sale charge as much as they can get away with affects minorities disproportionately. The result is the same as if there were deliberate discrimination.
The Market Segmentation Theory
A related explanation for why minorities pay more for their mortgages than whites, offered by CRL, is that minorities receive more of their loans than whites from high-price lenders. This would be true if high-price lenders target minorities more than whites, which would be patently illegal and which I doubt occurs.
Alternatively, high-price lenders probably do more high-powered soliciting than other lenders, and if minorities are more vulnerable to solicitations, they will end up with dealing with those lenders in disproportionate numbers. I suspect that this does indeed happen. It is why I constantly advise borrowers of every color not to respond to solicitations. I wish I heard more preaching on this subject from community groups.
The Community Group Approach to Unequal Treatment of Minorities
Community groups don’t accept my contention that discrimination arises from discretionary pricing by loan officers and mortgage brokers at the point of sale, because it takes lenders off the hook. Brokers and loan officers are a much less attractive target for them than lenders. A recent study by the Center for Responsible Lending (CRL) concedes that posted prices are free of bias, but claims that lenders influence the final prices in indirect ways that can be discriminatory. In my opinion, none of their arguments withstand close scrutiny (see my appendix note).
Community groups also don’t like the idea that loan officers and brokers are out to skin everyone but are more successful with minorities. This conclusion can be interpreted to mean that the victims are partially responsible for their own mistreatment.
In my view, this interpretation is sometimes unavoidable. Borrowers are victimized primarily because they are ill-informed, and given that the information that would protect them is widely available, they bear some responsibility for not finding and using it.
When this article appeared in the press, I received numerous letters complaining about Hispanic loan officers and brokers who took advantage of the Hispanic borrowers who sought them out. I have not verified these reports, but it would hardly be surprising if it were true. I would expect Hispanic loan providers would be equal-opportunity over-chargers, just like their white compatriots, except that they find better pickings in the Hispanic community.
Community Group Remedies Look to Government to Punish Lenders
In the community group vision of the mortgage market, lenders are the villains and minorities the victims. Their proposed remedies largely involve government increasing the burdens and responsibilities imposed on lenders. For example, community groups favor making lenders legally responsible for the suitability of the mortgages they provide in meeting the needs of borrowers. I am opposed to such a rule, for reasons discussed in Mortgage Suitability.
I wish the community groups did a better job of advising their constituents about how to avoid trouble. Their advice is directed at how to identify the bad guys, which in my view is the wrong approach. There are too many bad guys, and they are too good at disguising their true nature.
Why Don’t Community Groups Direct Borrowers to Loan Providers Who Won’t Rip Them Off?
The right approach is to identify the good guys and ignore the rest, the same approach used by savvy pickers of wild mushrooms. They only pick the ones they know are good. Picking the mushrooms that aren’t bad requires an ability to identify all the bad ones, which is more time-consuming and much riskier.
Minorities (and others) can avoid discrimination by selecting distribution channels where pricing discretion is either absent or controllable by the borrower. Pricing discretion is absent in internet-based lending, because loan officers don’t capture the customer and therefore don’t have the clout to dictate their terms of employment.
Internet-based lending offers other borrower protections as well. These include more complete information on lender fees and third party fees, and the ability of shoppers to monitor their price from day to day until they lock it. I certify lenders who provide all the information needed by borrowers to shop on-line as Upfront Mortgage Lenders.
Another way to avoid discrimination is to negotiate an all-in fee with a mortgage broker, the fee to include any payments received by the broker from the lender. While most brokers don’t work that way, preferring to keep their markup their own business, most of them will if the borrower insists on it. (Upfront Mortgage Brokers work this way as a matter of course). The borrower has the clout to dictate the terms of his engagement with the broker, if only he realizes it.
If the CRL and other community groups guided borrowers to lending channels where they would not be exploited, these channels could become the dominant delivery systems, and the channels where predators operate would shrink. This would require nothing of Government, whose track record in protecting mortgage borrowers is very poor.
Appendix Note: The CRL’s Case For Lender Culpability
CRL offers two explanations for why minorities pay more for their mortgages than whites. Their "market segmentation" explanation was discussed above. CRL’s "disparate pricing" explanation is that lenders charge minority borrowers more than comparable whites. They don’t accept that posted prices are free of bias.
"While rate sheets do present objective pricing schedules for calculating a loan’s interest rate, they are not definitive statements of a loan’s price for a given borrower. Discretionary yield spread premiums and other up-front charges, as well as negotiated exceptions to rate sheet guidelines are common examples of how a loan’s price can vary from prices displayed on a rate sheet." (p.20)
This argument does not hold water. Yield spread premiums are not discretionary, and rate sheet guidelines are never negotiated.
Yield spread premiums (YSPs) are another name for rebates (or negative points) paid by lenders to mortgage brokers on high rate loans, as illustrated in the table below.
Wholesale Prices on a 30-Year Fixed-Rate Mortgage
| Interest Rate | Points and Rebates |
| 6.25% | 3.375 points |
| 6.50 | 2.500 points |
| 6.75 | 1.125 points |
| 7.00 | 0.750 points |
| 7.25 | 0 |
| 7.50 | 0.625 rebate |
| 7.75 | 1.125 rebate |
| 8.00 | 1.700 rebate |
| 8.25 | 2.250 rebate |
YSPs are often associated with broker overcharges, because brokers may pocket them without the knowledge of borrowers. But the fact that rebates may be associated with broker abuse does not make them discretionary. The high rate/rebate combinations on the price sheet are firm offers by the lender in exactly the same way as low rate/high point combinations. Wholesale lenders are not involved in rebate abuse by brokers. It puts no money in their pockets.
Further, there are no "negotiated exceptions to rate sheet guidelines." Not all brokers get the same rate sheets, larger ones command slightly lower prices, but the individual prices on a rate sheet are never negotiated.
It is true that inquiries as to what the posted price is in a specific situation are common. The reasons are that pricing structures are extremely complex, price sheets cover only the most common programs and options, and brokers want to avoid making a costly mistake. However, inquiries are not "negotiated exceptions." The "broker reps" who deal with mortgage brokers and answer these questions, do not have authority to change the posted prices.