The Fleecing of Black Borrowers

By Lauren E. Willis
Sunday, October 8, 2006

According to new Federal Reserve Board data, less than one-fifth of non-Hispanic white borrowers took out high-priced loans last year. But for African Americans, the proportion was more than half. Black borrowers paid -- and will continue to pay for the life of these loans -- high prices at more than triple the rate that whites did. And Latinos were more than 1 1/2 times more likely than whites to pay high prices.

Liberals will cite these numbers as evidence of lending discrimination. Conservatives will argue that minorities should pay higher prices because they have lower incomes and less wealth, making them financially riskier. These explanations tell only part of the story.

The home loan market is what economists call "inefficient" and what the rest of us might call plain unfair: Minorities -- and many whites -- receive high-priced loans when they are financially qualified for lower-priced loans.

Why? As an official of the American Bankers Association, quoted in The Post, put it: "People shop more for a loaf of bread than they do for a mortgage."

But why don't Americans shop for the best loan price? Perhaps it's because loan officers and brokers present a certain price as "the rate for which you qualify" and some 40 percent of Americans then erroneously believe that under the law this is the best rate for which they qualify. Because lenders are less likely to suggest to minorities that they have any choice, more than 65 percent of African Americans believe this is indeed the rate they must pay.

Consumers who know that the law does not control prices may think their loan broker will shop for the best price. But lenders pay brokers kickbacks ("yield spread premiums") for selling loans priced higher than those for which borrowers qualify. Data show that brokers are more likely to fleece minority borrowers than white borrowers to "earn" these kickbacks.

Price shopping can impose a heavy psychological cost. Although discrimination in the granting of credit is no longer legal, over 27 percent of mortgage applications by African Americans were denied last year, more than twice the denial rate for white applicants. Years of denials may lead minorities to look for "guaranteed approvals" instead of the lowest price.

Borrowers who think their credit is poor may apply to a single lender promising high-priced "no doc" loans (in which less documentation of income is required) to avoid the embarrassment of what loan officers describe as "the financial strip search." But many borrowers, especially African Americans, underestimate their creditworthiness. This is often because of the message lenders send minority loan applicants.

In recent "mystery shopper" testing of mortgage brokers in six American cities, including Washington, blacks with good credit were asked whether they had debts, late payments, past foreclosures, etc., four times as often as white testers with worse credit profiles.

Consumers who shop discover that home loans today are mind-bogglingly complicated. Gone is the day of the cookie-cutter 30-year loan of equal payments every month. Now a 2/1 buydown 15-year balloon at 7.5 percent and 1.5 points must be compared to a 3/1 adjustable-rate 30-year mortgage at 7 percent with $7,000 in closing costs and a prepayment penalty. Few Americans can perform the calculations necessary to compare the prices of these loans.

What do higher home loan prices mean for the households saddled with them? Average prime rates on 30-year mortgages in December 2005 were about 6.3 percent, and, assuming that the rates on high-priced loans then were similar to the annual numbers, the average high-priced loan would have had a rate of 9.5 percent. On a $240,000 loan, that can mean the difference between a monthly payment of $1,500 and one of more than $2,000 -- a $190,000 difference over 30 years.

So what to do?

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