Reverse Redlining in the Subprime Mortgage Market: Comments on "Moving Toward Integration: The Past and Future of Fair Housing".

• Author: Mansfield, Cathy Lesser
• Position: Fair Housing Past, Present, and Future: Perspectives on Moving Toward Integration

My comments focus on the problem sometimes referred to as "reverse redlining," which entails mortgage loans made to borrowers of color on terms significantly less favorable and more expensive than mortgage loans made to white borrowers. I will also try to unpack the chicken-egg problem of mortgage defaults and foreclosures in the African-American homeowner community.

Let me start by saying that it is admirable that the authors seek to answer the question of why African-American borrowers received mortgage loans featuring higher interest rates and fees and more onerous terms, and why African-American borrowers experienced higher default and foreclosure rates during the subprime mortgage crisis. Without understanding why these things have occurred, it is harder to find public-policy solutions to these very real problems.

The authors start by recognizing and accepting a multitude of studies concluding that African-American and Hispanic mortgage borrowers were much more likely to receive subprime and predatory mortgages during the subprime-market era (roughly from 1990 until 2008) than white borrowers with similar credit profiles. (2) The authors also recognize and accept studies finding that default and foreclosure rates were higher for African-American and Hispanic borrowers than for similarly situated white mortgage borrowers. (3) In seeking to explain these truths, the authors then embark on a series of assumptions and conclusions that I will try to unpack here.

The authors suggest that because African-American and Hispanic default rates were higher, providing these borrowers with loans priced for this risk might not be discriminatory. (4) This so-called paradox actually served as the justification for what lenders in the subprime market called risk-based pricing. (5) The notion of risk-based pricing is that lenders can identify a borrower's default risk based on the borrower's credit history, and price the loan's features (including interest rate and fees) accordingly to compensate for the lender's risk. But this loan-pricing model ignores the fact that expensive loans create their own risk, and that there are numerous ways to structure a loan to a borrower with a particular credit profile--some of which will create a greater default risk than others. It also ignores the lender's incentive to write a loan that will maximize its immediate profit regardless of default risk, especially since those to whom the loan is assigned after origination will bear the default risk. Finally, risk-based pricing ignores the combined effects of discretionary pricing and explicit or implicit bias.

I would first like to debunk the notion that risk-based pricing matches scientifically determined loan terms with the borrower's credit quality. There are numerous ways to write a loan for a borrower who "deserves" a particular interest rate. Some of these ways help a borrower to successfully pay back the loan, while others create their own risk of default. Take, for example, the case of Beatrice Troup. In 1995, Ms. Troup, a then-seventy-four-year-old African American who had lived at the same home on Vanderpool Street in Newark, New Jersey for forty years, received a solicitation call from a home-repair contractor. (6) She ultimately hired the contractor and entered into a mortgage loan, arranged by the contractor, for exterior home repairs. (7) Ms. Troup's lenders required her to convey the home to herself and her son, Curtis. The lenders then issued the mortgage loan to both of the Troups. The loan had a principal amount of $46,500 which was to be repaid at an annual percentage rate of 11.65%. (8) The loan required monthly payments of $462.50, and a final balloon payment after fifteen years of $41,603.58. (9) Of the $46,500 lent to Ms. Troup and her son, the lender kept four points (4% of the amount loaned) as an origination fee. (10) Within two years after the loan was made, Ms. Troup stopped making payments on the loan, and the loan's holder, Associates Home Equity Services, filed for judicial foreclosure. (11) Ms. Troup's attorneys responded with claims for reverse redlining and predatory lending. (12)

The case itself had complex facts and odious conduct by several actors, and presented the court with numerous legal issues. But I want to focus here on two challenges to the notion that the lender priced this loan to reflect Ms. Troup's and her son's default risk. First, if we assume that the 11.65% interest rate was somehow justified because the Troups had a high default risk, this cannot be the end of our discussion. There are numerous ways to write a high-interest loan like this. Here, the lender chose to write it as a balloon loan. As Table 1 illustrates, that structure increased the loan's total repayment amount from $98,577 to $124,391.08. The only benefit to the Troups of writing the loan as a balloon loan was a slightly lower monthly payment of $462.50 (compared to $547.65 under a non-balloon structure). By writing the loan as a balloon loan, the lender may have slightly decreased the Troup's default risk in a given month (depending, of course, on their combined monthly income and debt-to-income ratio), but the lender also greatly increased the Troups' default risk--and also the risk they would lose their home--when the balloon payment came due--all while increasing the lender's own take from making the loan. Thus, even if the Troups somehow "deserved" an expensive loan, the lender...