After two years of research, Dr. Joe Darden of Michigan State University issued his report to the city of Grand Rapids on mortgage lending discrimination in the Grand Rapids Metropolitan Statistical Area (“Grand Rapids MSA”), which includes Kent, Ottawa, and Muskegon Counties. The central finding of the report is that mortgage loan applications from African-Americans and other racial groups are denied more frequently than applications from white borrowers. The report is valuable because it brings to light significant differences between various racial groups. However, the report fails to prove that those differences result from discrimination by lenders.
To identify racial disparities in lending, the report reviewed data collected by lenders during 1999 under the federal Home Mortgage Disclosure Act (“HMDA”). HMDA data are collected by banks and mortgage lenders with every consumer mortgage loan application they take in person or by mail. It is not collected when a customer applies by telephone.
HMDA data is limited in what it can tell us. The data include the race and income of the applicant and whether the loan was approved or denied. The data do not, however, include any other information that a lender would use to determine whether or not to approve an application, such as credit score, payment history, or job history.
Not surprisingly, the report showed that minority applicants are denied loans more frequently than white applicants. This is consistent with the data nationwide. For example, nationwide, African-Americans are denied loans at a rate twice that of white borrowers. However, because denial rates do not take into account the factors that indicate an applicant’s creditworthiness, a difference in denial rates between minority and white applicants cannot explain why a loan application was denied or whether it was the result of discrimination. Only after differences in credit characteristics are factored into the analysis could we reach any conclusion about whether race played a factor in the decision.
For example, one credit characteristic creditors look at to establish an applicant’s ability to repay a loan is income. In underwriting a loan, it is crucial for a lender to determine whether the borrower has sufficient income to make the loan payments. HMDA data include the applicant’s income. We can look at the loan-to-income ratio of applicants and compare the treatment of different ethnic groups. The analysis is still rudimentary, because many other factors – such as length of employment and credit history – go into an applicant’s creditworthiness. Yet, analyzing an applicant’s income sets us on the right track to discovering the cause of denial disparities.
If we use the loan-to-income ratio to compare, for example, African-Americans and whites in the city of Grand Rapids who applied for, and were denied, a refinancing loan in 1999, we see that African-Americans and whites who were denied loans had virtually the same loan-to-income ratio (1.814 for African-Americans versus 1.864 for whites). This suggests that income, rather than race, may explain the difference in the denial rates between African-Americans and whites.
This example highlights the importance of a careful understanding of what the City’s report can tell us. The report can tell us whether loan applications from different racial groups were approved at the same or a different rate. But it cannot tell us why differences exist or whether a lender applied its underwriting criteria fairly to all applicants. In short, the report cannot tell us whether there is discrimination in the mortgage lending market.
The Grand Rapids report is valuable because it identifies many areas in which there are disparities between the races. The study makes some inferences based on publicly available data. But since a full range of data are not publicly available for review, it is impossible to conclude whether or not racial discrimination explains the differences observed.
While the study does little to explain why those disparities exist, its findings can be valuable to lenders. Mortgage lenders need regularly to monitor their loan denials to ensure that denials are made based on credit characteristics, and not race. Mortgage lenders need to have a second review process, where denied applications are given a second look. While most lenders have instituted second review, lenders need to analyze their second review process to make sure that it is serving the purpose of ensuring that underwriting criteria are applied equally.
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Rodney D. Martin is a partner in the Grand Rapids office of Warner Norcross & Judd specializing in banking and financial institutions law. He may be reached directly at 616.752.2138. Because each situation is different, this information is intended for general information purposes only and is not intended to provide legal advice.