In the early 1960s, John F. Kennedy pledged to end housing discrimination ‟with the stroke of the pen." Naturally, activists deluged his office with thousands of pens as a sign of encouragement.
Half a century later, a study conducted by the online real estate database Zillow (NASDAQ:ZG) reveals that the experiences of minorities in the housing market still differ greatly from those of whites. This inequity is holding back positive economic growth in minority communities and may also present a threat to the health of the entire U.S. housing market.
The report, titled ‟A House Divided: How Race Colors the Path to Homeownership" and released on Thursday, is based on data gathered from Zillow's internal Home Value Index and the Home Mortgage Disclosure Act, as well as responses to a randomly administered online survey of adults who had applied for a mortgage in the past year. The report found that not only do far fewer African Americans and Hispanics apply for conventional private mortgages than do whites, but when they do apply, their applications are turned down at a much higher rate.
‟Although Hispanics and blacks make up 17% and 12% the U.S. population, respectively, they represented only 5% and 2% of the conventional mortgage application pool," the report reads. "Blacks experience the highest loan application denial rates -- 1 in 4 blacks will be denied their conventional loan application, as opposed to 1 in 10 whites."
This disparity in access to mortgages manifests itself in home ownership rates that are far lower among minorities. Nearly 74% of whites own a home; but rates for Asians, Hispanics and blacks are 61%, 51%, and 46%, respectively.
Zillow Chief Economist Dr. Stan Humphries explained that the largest factor contributing to the lower mortgage application rate among minorities is that people from those groups tend to have lower incomes. While the study wasn't able to look at the amount of savings held by the applicants, Humphries speculated that the lower incomes also translated to lower levels of savings. Combined with credit scores, which a 2007 Federal Reserve study found vary ‟substantially" by race, these three elements are crucial in determining whether someone will be approved for a mortgage.
Humphries worried that the lack of access to private mortgages has long-term economic implications for minority communities. "Home ownership is a pathway into the middle class because it is a mechanism for forced saving with homeowners continually putting equity into the maintenance of their homes," he said. "In the rental market, getting any American to save money is a difficult proposition."
"Unfortunately, the report reflects a long history of unfair lending practices targeted at minorities," insisted Alan Jenkins, executive director of the Washington, D.C.-based housing advocacy nonprofit The Opportunity Agenda.
Jenkins charged that the roots of the problem run deeper than simply being an outgrowth of larger economic disparities between different racial and ethnic groups. "Even when you control for other factors, you see higher income families of color experiencing discrimination when it comes to housing," he said. ‟It's not just about income, there's a real racial bias in the system."
While the Zillow report found that many minorities have had difficultly obtaining mortgages though the private market, it noted that they both applied and were approved for loans through the Federal Housing Administration (FHA) at much more representative rates.
David Stevens, the president of the Mortgage Bankers Association who ran the FHA from 2009 to 2011, explained how recent years have seen an increased reliance by minorities on FHA loans as a pathway to home ownership. He said that, over the past year, three-quarters of African Americans who purchased homes did so with an FHA loan—a massive swing toward the public sector in the years since the start of the recession, prior to which most minorities received mortgages though private firms.
The problem, Stevens explained, is largely that the secondary market for home loans is dominated by Fannie Mae (NASDAQOTH:FNMA) and Freddie Mac (NASDAQOTH:FMCC). "If you have to sell your loans to Fannie and Freddie, you have to abide by their rules, which now strongly penalize borrowers with low savings and low credit scores."
Unlike private loans, which set down-payments based on the risk of the individual borrower, many of the parameters for FHA loans are set at a flat rate. This option can be more attractive to households without a glut of money in the bank. An inability to afford the down-payment is often the biggest roadblock to home ownership, especially for people in communities without high rates of savings.
"[During the housing bubble], we created an unsustainable environment where we were pushing loans on absolutely everyone," Stevens explained. ‟The pendulum can swing too far in either direction. But now we've over-corrected and wealthy white guys are going to get all the loans they want and there are too many people being swept out with no access."
The decreasing minority access to home loans may be a leading indicator of a broader dysfunction within the entire private mortgage industry. For one, interest rates on conventional 30-year mortgages are at historic lows, well under 5%. It's likely that many financial institutions feel they could get a better return on investment elsewhere. In a recent article published on American Banker, bank advisor Joe Garrett urged those in the industry to think long and hard about getting out of mortgage banking entirely due not only to increased compliance costs and the possibility of low earnings, but also because offering home loans to customers doesn't have the same significance it once did.
"One of the great myths of our industry is that a mortgage is the foundational product for consumer relationships," Garrett writes. "With many people having their mortgage payment automatically taken from their checking account, a significant number of borrowers don't even know who their mortgage lender is. And mortgage borrowers are much more interested in getting the lowest rate than in getting a mortgage from their primary bank."
As a result of attitudes like Garrett's, mortgage lending is consolidating into a grips of a handful of megabanks—most notably Wells Fargo (NYSE:WFC). Its mortgage lending in the fourth quarter of 2013 is down 60% from the prior year, with the loans it did issue largely going to the safest possible candidates. "The people being left out right now are those whose credit scores are average," said Julia Gordon, a director at the Center for American Progress in an interview with the New York Times. "It's just your typical American family with a credit score in the high 600s or low 700s."
For his part, Humphries worries about the long-term implications for a two-tiered system. "The conventional market is very risk-averse right now, requiring larger down-payments that many minorities can't afford, and the FHA is seen as picking up some of that slack by accepting riskier mortgages," he explained. "That additional risk is ultimately borne by the taxpayers."
Humphries said he would like to see the two mortgage markets converge a bit, with private lenders becoming more willing to take on additional risk from minority communities. This would allow the FHA, which is tasked with expanding access to housing to groups under-served by the private market, to get some of the resulting risk off of its balance sheet.