Subprime Mortgage Pricing: The Impact of Race, Ethnicity, and Gender on the Cost of Borrowing

The subprime lending boom increased the ability of many Americans to get credit to purchase a house. Yet concerns persist that not all borrowers have been treated equally. Previous research suggests that subprime loans were particularly concentrated in neighborhoods with a high concentration of black and Hispanic residents (Mayer and Pence 2007). Some commentators have been concerned that minority borrowers were steered into subprime loans in some cases when they might have qualified for cheaper conforming loans or that minority borrowers were given subprime loans that had fees or rates that were too high.

Previous research on housing markets suggests that such concerns might be warranted. Beginning in the early 1990s, data collected from lenders through the Home Mortgage Disclosure Act (HMDA) indicate that black or Hispanic applicants were more likely to be rejected for a mortgage relative to a white applicant, even when controlling for credit scores or other observable individual risk factors (Munnell and others 1996). Subsequent research showed that minority borrowers might also have been more likely to default on loans, but these findings were less clear in that they did not control for basic ex-ante risk factors (Ladd 1998). Even controlling for the likelihood of default, Canner, Gabriel, and Wooley (1991) argued that minorities still face reduced access to conventional lending markets.

Recent studies of consumer loans have amplified concerns that minorities still face disparate treatment when applying for credit. For example, Charles, Hurst, and Stephens (2008) showed that blacks pay appreciably higher rates than other borrowers when financing a new car. Some portion of the higher payments comes from a higher proportion of blacks who use more expensive finance companies, but even among borrowers with comparable risk profiles using finance companies, blacks still pay higher rates. Similarly, Ravina (2008) found that black borrowers on Prosper.com, a successful online lending market, pay rates that are more than 1 percent higher than comparably risky white borrowers. Ravina attributed the higher rates for blacks to the fact that black lenders, who do not charge higher rates to black borrowers, are relatively under-represented on Prosper.com relative to black borrowers.

Despite the size of the mortgage market, as well as previous evidence on racial and ethnic differences in access to lending for housing, there are no recent studies that we have found on mortgage rates for minority borrowers. Below, we examine mortgage rates charged to a group of subprime mortgage borrowers using an innovative new dataset created by merging information on the race, ethnicity, and gender of mortgage borrowers (as reported under HMDA) with mortgage pricing and risk variables reported by LoanPerformance (LP). Through extensive work, we have been able to match approximately 70 percent of loans in LP to a unique mortgage in HMDA. The merged dataset allows us to examine racial, ethnic, and gender differences in mortgage lending, controlling for both the risk profile of the mortgage and the characteristics of the neighborhood where the property is located.

As the subprime market took off between 2000 and 2006, a variety of new products became available for financing housing. The available contracts were differentiated along many dimensions, including term, amortization schedule, and the allocation of future interest rate risk between borrower and lender. Because each of these features has effects on the value, timing, and probability of repayments, the precise way that they are combined into products will affect their value to borrowers and lenders. Thus, if we are to understand the pricing of loans, it is important that we examine a specific part of the market at a particular time, so that loan features and credit conditions are common for all the contracts we observe.

We focus on so-called 2/28 mortgages originated in August 2005. The 2/28 is a hybrid adjustable rate mortgage (ARM) in which borrowers are charged an initial mortgage rate for two years, followed by biannual rate resets based on a margin over a short-term rate. The 2/28 was a very popular form of subprime borrowing, and it...