(This is Part 1 of a two-part series. Read Part 2.)

“I read about a study recently claiming that African Americans and Hispanics paid more for mortgages than white borrowers who were otherwise similar. Do you believe this to be true, and if so, why does it happen, and what should be done about it?”

I have looked at the studies, including a very recent one by the Center for Responsible Lending (CRL). While most of the studies leave out important differences between the groups, including credit scores, the CRL study takes into account credit and other relevant factors, and its findings are the same. They find that minorities generally pay more, which rings true to me.

To understand how and why it happens, it is necessary to understand how mortgages prices are determined. In more than 90 percent of the transactions, it is a two-stage process. Stage 1 is the development of posted prices that are delivered to loan officers and mortgage brokers. Stage 2 is the determination of final prices paid by the borrower.

Posted prices are either retail or wholesale. Wholesale prices are posted by wholesale lenders to mortgage brokers and correspondent lenders (CLs). (Unlike brokers, CLs fund loans, but they deliver them to the same wholesale lenders as brokers. Henceforth, I use the term “brokers” to include CLs). Retail prices are posted by retail lenders to their loan officer employees.

Mortgage prices are delivered by fax or (increasingly) over the Internet in the form of “price sheets.” These sheets are voluminous because each loan program must be priced separately and because pricing has become so complex. Prices vary with the borrower’s credit, purpose of loan, type of property, type of documentation, state location of property, and other factors.

Posted prices do not vary with race, which would be blatantly illegal. Neither do prices vary with proxies for race, such as property location. Minorities are much more heavily concentrated in center cities than in suburban areas, for example, so mortgage pricing based on this distinction could be discriminatory. However, lenders do not make such distinctions in their pricing. Most lenders in their pricing use only states. Some divide large states such as California into regions, but the regions don’t correspond to any racial divisions.

The upshot is that lenders do not discriminate in their posted prices. I have looked at the price sheets of hundreds of lenders, both wholesale and retail. I have never seen one that had even a whiff of discriminatory treatment of minorities. The unequal treatment of minorities occurs at the second stage, where posted prices are converted into final prices to the borrower.

In the wholesale market, lenders deliver wholesale prices to brokers, who add a markup to derive the retail prices offered to borrowers. If the posted price is 6 percent and zero points, for example, a broker might offer the loan at 6 percent and 1.5 points, the 1.5 points being the markup.

Within very wide limits, brokers have complete discretion over the final price. They are independent contractors who price as they please. Some wholesale lenders place limits on markups, but these limits are absurdly high. Since there are hundreds of wholesale lenders, and brokers move easily from one to another, any one lender attempting to enforce more rigorous constraints on markups would quickly lose brokers.

In the retail market, lenders deliver retail prices to their loan officer employees (LOs). The lender’s markup, including the LO’s commission, is already included in these prices. However, LOs have limited discretion to charge more than the posted prices “in order to take advantage of market opportunities,” and to charge less “in order to meet competition.” Such price deviations are termed “overages” and “underages,” respectively. Overages exceed underages by a wide margin.

The great majority of brokers and LOs are “equal-opportunity over-chargers.” They charge what the market will bear, without regard to race or color. Some are no doubt prejudiced, and if they had any market power to go along with their pricing discretion, they might use it to discriminate against minorities. Because the competition for customers is so intense, however, any such attempts would cost them money.

On the other hand, there may be a perception that minorities are easier to take advantage of than whites. To the extent that this is true, a market in which loan providers at the point of sale charge as much as they can get away with affects minorities disproportionately. The result is the same as if there were deliberate discrimination, but the implications for remedial actions could be quite different. Remedies will be discussed next week.

The writer is Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.

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