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Arun Jambulapati
7 April 2014
Dr. Douglas Campbell
ECON 4766

Loan Discrimination and its Effect on American Racial Minorities

Loan discrimination is the practice of lending institutions, such as banks and the
government, demanding higher interest rates on or refusing loans to a group of people due to
their race, gender, or religion. Although banks are usually thought of as nondiscriminatory
institutions, their behavior when loaning to minority households indicates a significant
difference between the loan conditions of white families and nonwhite families. In this paper,
I will analyze the problem of loan discrimination at length, describing studies showing its
existence, considering the objections of some critics to these studies, and elaborate on some
potential causes and effects of loan discrimination.

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Loan discrimination has been demonstrated by numerous studies. For example,
African American and Hispanic households are 82% more likely to have a loan application
rejected compared to their white counterparts, even after controlling for credit score and the
type of loan offered (Danziger, Haveman 375). Although the study, known as the Boston Fed
Study, has been criticized for flaws in its methodology and data set, an independent review
conducted by Glennon and Stengel reached a conclusion supporting the Boston Feds result;
they found that approximately half the difference in denial rates can be attributed to
differences in the financial characteristics of the borrowers and the neighborhood
characteristics of the property; the remaining half can be attributed to differences in
treatment by race (Glennon and Stengel, i). However, it is entirely possible that this
discrimination arises due to some external factor, such as income. Since racial minorities
earn less on average than whites, it is logical to think that the disparity in loan r ejections is
due to the difference in income. However, the Boston Fed study controlled for credit score,
which both accounts for income in the form of the debt-to-income ratio used to compute
credit scores and also predicts the ability to pay back a loan with more accuracy than income,
as credit scores are predominantly scored on the basis of loan history.
Therefore, since there are no other factors that can explain the apparent
discrimination, we must conclude that the Boston Fed study found that minority groups are
strikingly discriminated against by lending institutions. However, this discrimination might
not be racially motivated. Other factors, such as misconceptions on the behavior of minority

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households or implicit or unconscious discrimination, might contribute to the 82%
difference. These factors might explain at least some of the apparent racial discrimination.
Studies have shown that African-Americans are unconsciously discriminated against, even
by people without explicitly racist ideas. For example, a study performed by Cunningham,
Preacher, and Banaji revealed greater association between white and good and between
black and bad than between white and bad and between black and good; they
specifically found that people tend to associate black faces with bad things and associate
white faces with good things. (Cunningham, Preacher, Banaji 169) This effect might cause
bankers to see black families as less trustworthy than similar white families, and therefore
charge them a higher interest rate or deny them a loan altogether. However, regardless of
whether or not such discrimination is racially motivated, banks are still at fault for it, as
regardless of the causes of the discrimination the effects are very real and can keep even
financially stable minority families from buying a house.
In addition to making it harder for minority families to obtain a loan, mortgage
discrimination also forces minority families to pay a higher interest rate on a loan they
received versus a comparable white family. Work by Krivo and Kaufman has shown that
African Americans and Hispanics are between 1.5 and 2.5 times more likely to pay a 9% or
higher interest rate on a mortgage. In addition, the average African American household pays
a 0.39% higher interest rate than the average white household, while the average Hispanic
family pays 0.17% more than the average white household. (Krivo, Kaufman 602) These

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differences may seem small, but figures from the same paper indicate that the 0.39%
difference between African American and white home loans leads to blacks paying an extra
10.67% of the value of the home in loan premiums, while Hispanics pay an extra 4.3%
compared to whites, very considerable differences for purchases of such value. (602) It is
also important to note that the sample in these statistics automatically excludes households
who were not able to get a mortgage. What this means is that even after banks presumably
denied loans to all of the minority households who were deemed unfit for a loan, and even
after more minority applicants had their loan application rejected compared with a
comparable white applicant, lending institutions still charged minority applicants higher
interests on average and also asked more minority applicants for high interest rates.
This disparity, however, has several plausible explanations. For example, the average
home of an African American or Hispanic household is considerably lower than the average
home of a white household. Krivo and Kaufman state that the value of the average home
owned by a white household is at least $20,000 more than the value of the average home
owned by an African American or Hispanic household. (Krivo, Kaufman 597) In addition, a
study performed at Brandeis University by Thomas Shapiro, Tatjana Meschede, and Sam
Osoro found that in late 2008, the average white familys net worth was $265,000, while the
average black familys net worth was only $28,500, a more than nine fold difference
(Shapiro et al, 2). The first factor is likely irrelevant, however, since on the scale on which
banks lend, the lower home value should not have any effect on the profit -to-cost ratio of

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their loans. However, the second factor may play a role in explaining the interest rate gap, as
it is possible that the lower wealth of minority groups may cause them to be unable to make
loan payments should something go wrong, such as if one of the households members loses
his or her job. This effect was seen during the 2008 housing crisis, as research done by
Bocian et al. in a CRL Research Report found that African American and Hispanic
homeowners were 76 and 71 percent more likely than whites, respectively, to foreclose on a
housing loan. (Bocian et al, 8) Bocian et al. also found that African Americans and Hispanics
were considerably more likely to default on loans than were whites at any income level, and
that the disparity actually increased as income did. (9) The increased foreclosure rate is
likely due in part to the lower level of wealth of minorities, compared to whites.
This, however, does not detract from the Boston Fed studys conclusion that African
Americans are overall far more likely than whites to have a loan application rejected, since
that study also controlled for household wealth. In addition, the authors of the CRL Report
also state that this effect is also due in part to the fact that minorities were disproportionately
more likely to have a subprime mortgage on their home (6). According to their report,
Previous research has shown that African-American and Latino borrowers were about 30%
more likely to receive the highest-cost subprime loans relative to white subprime borrowers
with similar risk profiles and that minority groups were more likely than whites to have
loans with prepayment penalties. (6) This disparity, as opposed to the interest rate disparity,
cannot be easily explained, as after adjusting for risk profile it is difficult to see a reason

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other than mortgage discrimination for banks to give high cost subprime loans so much more
often to blacks and other groups of color than to whites.
A possible explanation for the higher rate of subprime mortgages among blacks is that
African Americans as a whole are not as fit for loans compared to whites. This would imply
that they could not receive a normal, non-subprime loan, and instead were forced to take a
subprime loan with a higher interest rate. However, the study cited in Bocian et al. controlled
for risk profile, meaning that any risk differences between whites and blacks was factored
out before the statistics were measured. It is possible to counter by saying that a states
minority population as a ratio to its full population and its overall foreclosure rate are
positively correlated, implying that minorities are less able to pay mortgage payments than
whites and therefore charged higher interest rates in subprime mortgages. This correlation
can actually be demonstrated, as data from the 2010 US Census combined with data from
Demographias 2008 survey of foreclosed houses combine to give a correlation coefficient of
0.35. This is a small positive correlation, but a positive correlation nonetheless. This positive
correlation implies that a state with a high percentage of minorities is more likely to have a
high rate of foreclosures. However, it is not entirely clear which way this correlation points.
It is possible that minorities are less able to pay home loans as a whole, thereby causing
higher foreclosure rates by the mechanism described above, but it is also possible that the
overconcentration of subprime loans among communities of color, (caused by some reason
other than loan risk, as demonstrated above) caused them to foreclose in larger numbers than

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compared to their white counterparts. This would have the effect of increasing the
foreclosure rate in states with a larger number of minorities. In actuality, due to the other
statistics mentioned in Bocian et al, it is probably more likely that the latter causal link holds.
What this all points to, then, is that while mortgage discrimination might not be the
primary factor influencing the differences in interest rates on mortgages, it is the only
explanation for the gap in mortgage application rejections and for the difference in subprime
mortgage rates. In addition, while mortgage discrimination might not be the main factor in
the difference in interest rates, it is still likely a secondary factor, as it seems implausible that
mortgage discrimination has an effect on loan rejections but no effect on loan interest rates.
Now that I have discussed at length some studies demonstrating mortgage
discrimination and their critical objections, I will now analyze the potential causes and
effects of mortgage discrimination. On the face of it, it seems strange that a profit -oriented
organization would discriminate only against racial minorities and thereby hurt their profit.
However, this assumes that discrimination actually hurt the banks profit and that banks care
solely on profit. On the latter note, it is feasible that some small banks with one or a few
owners with racist intentions may get some utility from discrimination that exceeds the loss
of profits disutility. However, such banks are typically small both in size and number,
meaning that the vast majority of home loans would not be given by such racist banks.

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It is far more likely, however, that discrimination might not necessarily hurt profits.
For example, the CRL report states that before the 2008 financial crisis, the lenders
compensation was based on the volume of their transactions, not loan performance and
consequently many lenders aggressively marketed and originated loans without due regard
for borrowers ability to repay them. (Bocian et al, 13) Since lenders had an incentive to sell
as many subprime housing loans as they could without having to make sure the performance
of the loans they sold were stable, any unconscious biases they might have held could have
manifested as giving more subprime housing loans to minority groups. While it is a stretch to
believe every lender did so, minority home buyers tend to be less well educated compared to
their white counterparts (Segal, Sullivan 59) and bought homes in larger concentrations than
whites in the period from 2000 to 2007. (Housing Vacancies and Homeownership, Table 22)
This means that they were possibly less savvy to the unfair and unethical lending practices of
lenders and that they were disproportionately more likely to have sought a home loan during
the housing bubble, giving them as a whole a disproportionately higher incidence of
subprime mortgages. This indeed seems like a plausible explanation for statistic that African
Americans were 30% more likely than their white counterparts to have a subprime mortgage,
as minority groups as a whole, and African Americans especially, sought home loans in
disproportionately greater numbers than whites did during the time when subprime
mortgages were most widespread. However, this difference only amounts to less than one
percent, meaning that it cannot possibly explain the 30% gap in the statistic.

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Now, I will discuss some of the effects of loan discrimination. The study conducted at
Brandeis University that was mentioned earlier states that The data in this report clearly
target homeownership as the biggest driver of the racial wealth gap and further we need to
ensure that mortgage and lending policies and fair housing policies are enforced and
strengthened so that the legacy of residential segregation no longer confers greater wealth
opportunities to white homeowners than it does to black homeowners. (Shapiro et al. 6) The
authors of that study claim that a house is the primary asset of most home owning families
and therefore discriminatory lending practices, like the ones mentioned earlier in this paper,
must be stopped to see an improvement in the wealth gap. Mortgage discrimination also has
the effect of causing homeownership rates among minorities to be artificially lowered by
making it harder for them to find a loan with a reasonable interest rate. This difference in
homeownership rates can clearly be seen in the US Census Housing Vacancies and
Homeownership Annual Report, which shows that the difference between the white
homeownership rate and the black homeownership rate is an enormous 26.5%, while the
difference between the white homeownership rate and the homeownership rate of all other
minorities is a still-large 13.5%. Although these differences cannot be entirely attributed to
housing discrimination, housing discrimination is likely a major contributing factor, and the
existence of such discrimination is therefore a major factor in depriving minority children of
the educational and social benefits of having a house.

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In conclusion, mortgage discrimination is a complicated topic with many different
causes, effects, and manifestation. In this paper, I have documented some of the visible
manifestations of mortgage discrimination, such as in loan rejection, interest rates, and
subprime loan rates, as well as some of its causes and effects. It is clearly an important
problem that must be addressed due to its detrimental effects on a significant portion of the
American population.
Works Cited
Danziger, Sheldon, and Haveman, Robert H. Understanding Poverty. New York: Russell
Sage Foundation, 2001. Print.
Glennon, Dennis, and Stengel, Mitchell. "An Evaluation of the Federal Reserve Bank of
Boston's Study of Racial Discrimination in Mortgage Lending." Office of the
Comptroller of the Currency, Apr. 1994. Web. 7 Apr. 2014.
Cunningham, W. A et al. Implicit attitude measures: Consistency, stability, and convergent
validity. Psychological Science, 12, 2001, 163170.
Krivo, Lauren J. and Kaufman, Robert L. Housing and Wealth Inequality: Racial-Ethnic
Differences in Home Equity in the United States. Demography, 41 (Volume
3), 2004: 585605.

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Shapiro, Thomas et al. The Roots of the Widening Racial Wealth Gap: Explaining the
Black-White Economic Divide. Institute on Assets and Social Policy, February 2013.
Web. 26 Apr. 2014.
Bocian, Debbie Gruenstein et al. Foreclosures by Race and Ethnicity: The Demographics of
a Crisis. Center for Responsible Lending, February 2010. Web. 26 Apr. 2014.
US Census, 2010. State and County Quickfacts. US Census, 2010. Web. 27 Apr. 2014.
Accessed at quickfacts.census.gov .
Demographia. Subprime Mortgages and Housing Price Increases by State: 2000 to the
Peak of the Housing Bubble. Demographia, February 2009. Web. 27 Apr. 2014.
Segal, Lewis M. and Sullivan, Daniel G. Trends in Homeownership: Race, Demographics,
and Income. Federal Reserve Bank of Chicago, 1999. Web. 27 Apr. 2014.
US Census. US Census Housing Vacancies and Homeownership Annual Report. US
Census, 2013. Web. 27 Apr. 2014.