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March 20, 2000
"I have read that in
recent years loan rejection rates have increased, especially among
lower-income people and minorities�Why do they continue to get the short
end of the stick?"
You are
correct about the rising rejection rate. According to a recent Federal
Reserve study, in 1993 lenders rejected 17.2% of all applications for
conventional loans (those not insured by the Federal Government) for home
purchases. In 1998, the rejection rate was 29.2%, an increase of 70% over
1993.
You aren't correct, however, in
blaming lender prejudice against minorities. The rejection rate for white
applicants increased by 70% between 1993 and 1998, compared to an increase
of 58% for blacks and 54% for hispanics.
What then was the cause? When a
housing finance system extends its reach to previously under-served
groups, rejection rates invariably rise.
Some years ago I was on the board
of a major lender that adopted a very aggressive program to reach out to
lower-income households and minorities. We discovered that the greater
our effort to find borrowers, the higher our rejection rate. Lower-income
loan applicants had more credit problems than higher-income applicants,
and minorities had more credit problems than whites.
Our rising rejection rate
attracted attention from both regulators and community groups looking for
bias. A high rejection rate is a red flag inviting unfriendly scrutiny.
But there was little interest in the low-income and minority applicants we
approved, who never would have applied without our outreach program.
Exactly the same thing happens
when the entire system extends its reach down market. The 1993-98 period
saw the remarkable growth of what is called the "subprime"
market. In 1998, subprime lenders accounted for 34.1% of all home purchase
conventional loan applications, compared to only 10.3% in 1993.
Subprime lenders offer loans to
borrowers who don't meet the underwriting standards of prime lenders. The
most common reason is that the applicant's credit score is too low,
reflecting a poor payment record on past obligations. Other factors
include a ratio of monthly housing expense to income that is well in
excess of what lenders view as acceptable; excessive amounts of short-term
debt relative to income; and the inability or unwillingness of applicants
to document their income or assets.
While subprime lenders apply more
liberal underwriting standards than prime lenders, they also have higher
rejection rates. Since the subprime market has become a larger part of the
total market than it was, overall rejection rates are higher.
The other side of the coin is the
large number of approved loans to households who otherwise would have been
shut out of home ownership because they couldn't obtain loans in the prime
market.
Home ownership for the poorest
households, those in the lowest 25% income bracket, rose by 6.2% between
1992 and 1998. Home ownership for those in the highest income bracket rose
only 1.4% during the same period, according to the U.S. Census Bureau. By
ethnicity, the home ownership rate increased by 4.3% for whites, 8.2% for
blacks, and 12.0% for hispanics.
Certainly, everything is not
peaches and cream in the subprime market. More subprime than prime
borrowers are overcharged because more of them are unsophisticated, or
don't shop, or both. In an earlier column, I suggested as a remedy that
mortgage brokers be required to quote their prices in advance. This would
eliminate most of the abuses in this market.
The price controls and other
draconian restrictions that some state legislatures have imposed on
subprime lenders is the wrong way to go. These restrictions shut out some
borrowers from the subprime market, denying them home ownership.
Copyright Jack Guttentag
2002
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