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Lending Discrimination and the Costs of Credit to People of Color

July 22, 2016
In 2005, an African-American woman applied for a mortgage on an investment property and Wells Fargo offered her a subprime loan [1]. It usually offered borrowers with similar credit scores prime loans with lower fees and fixed interest rates [1]. During the recession, the interest rate increased on her adjustable rate mortgage and her tenants stopped paying rent [1]. Having difficulty paying her mortgage, she sought a loan modification but the bank denied the request [1]. This borrower was over 90 years old and had a credit score better than, in the top fifth of all borrowers [1]. She received more than $20,000 in damages from the U.S. Department of Justice’s (“DOJ”) settlement with Wells Fargo Bank for their discriminatory lending practices [1].

by Ryan B. Smith, JD’17

Disclaimer: The opinions expressed below are those of the author and in no way reflect the opinions of the Department of Justice or its employees. 

Discrimination in lending drives up the costs of credit for millions of Americans. A borrower faces higher rates or less favorable terms based solely on his or her race. Lenders no longer have explicitly discriminatory policies, though such policies were prevalent until the passage of Title VIII of the Civil Rights Act of 1968 and the Equal Credit Opportunity Act of 1976. Nonetheless, loan officer discretion continues to create unfair outcomes. Discretion is the source of denials of qualified applicants or more expensive loans, and contributes to an unstable market.

Controlling for objective factors, the race of an applicant still influences the availability and cost of loans. Recently, the DOJ entered into settlement agreements with two of the biggest lenders in the country – Countrywide and Wells Fargo – when their discriminatory lending practices were uncovered. Investigators discovered that the lenders offered African-American and Hispanic borrowers less favorable terms than similarly qualified non-Hispanic White borrowers. The banks agreed to pay hundreds of millions of dollars to settle the lawsuits.

In United States v. Countrywide Financial Corp., Countrywide agreed to pay $335 million to African-American and Hispanic borrowers to resolve the United States’ claims of discrimination [2], [3]. From 2004-08, Countrywide made over four million residential mortgage loans [2]. The United States gathered evidence that the lender overcharged some 200,000 borrowers through higher rates and fees for loans [4]. Countrywide steered approximately 10,000 more borrowers into “subprime” loans while similarly qualified non-Hispanic White borrowers were offered “prime” loans [4]. Banks issue subprime loans to riskier borrowers, typically those with a credit score of 640 or lower. Banks offer prime loans, which have lower interest rates and fees, to less risky borrowers. Countrywide issued subprime loans to African-American and Hispanic borrowers while offering similar non-Hispanic White applicants prime loans [4]. The lender allowed its loan officers to depart from objective, risk-based criteria in setting rates and fees, resulting in discretionary pricing [4].

Average Cost of Discrimination to Individual for a $200,000 Loan [4]

For individual borrowers, these practices meant credit was more expensive. When buying a home in Los Angeles or Chicago in 2007, the borrower’s skin color could add $400-1,200 in fees and interest, or more [4]. For the average mortgage in L.A., Hispanic borrowers paid $545 more for a $200,000 loan than non-Hispanic White borrowers [4]. African-American borrowers paid $415 more [4]. At the same time in Chicago, Hispanic and African-American borrowers paid $795 and $460 more, respectively [4].

It was even more expensive to go through a mortgage broker, an agent who matches applicants to lenders for a fee or commission. Wholesale customers, those who buy from brokers, in the same racial groups in L.A. paid $1,100-1,235 more on average for a $200,000 mortgage [4]. In Chicago, they paid $970-1,195 more [4]. See figure 1. The 10,000 customers who were wrongfully placed in subprime loans paid thousands of dollars in extra rates, fees, and penalties, and faced higher rates of foreclosure [4].

Similar facts were the basis of the United States v. Wells Fargo Bank, N.A. case [5]. “Since 2008, Wells Fargo has been the largest residential home mortgage originator in the United States, and now originates more than one out of every four mortgages in the country” [5]. The lender placed thousands of African-American and Hispanic borrowers who should have qualified for prime loans into subprime mortgages. Wells Fargo created an incentive structure for its loan originators that encouraged discrimination, paying loan officers more when they placed borrowers into subprime loans [5]. For a $300,000 mortgage, a broker could make $1,500 more by steering a borrower into a subprime loan [6]. Nationwide, African-American borrowers were 5.6-8.3 times more likely to receive a subprime loan from Wells Fargo than non-Hispanic White borrowers [6]. Wells Fargo ultimately settled with the DOJ for more than $175 million [5].
The discriminatory practices of Countrywide and Wells Fargo, two of the nation’s largest residential mortgage providers, cost African-American and Hispanic borrowers hundreds of millions of dollars because of their skin color. Lending discrimination occurs in other areas such as credit cards, personal loans, home improvement loans, and auto loans [1]. In addition to contributing to institutionalized oppression, lenders create an unstable credit bubble by allowing discretion and using subjective factors to make loans. These cases illustrate that discrimination in lending is still prevalent in the United States and its costs are high to individuals, banks, and the economy.


References

  [1] Vanita Gupta, “The Attorney General’s 2014 Annual Report to Congress Pursuant to the Equal Credit Opportunity Act Amendments of 1976.” Washington, D.C.: United States Department of Justice, 2015. [Online]. Available: https://www.justice.gov/crt/about/hce/documents/ecoa_reports/ecoareport2014.pdf. [Accessed: June 19, 2016]. 

  [2] United States v. Countrywide Financial Corp., No. 2:11cv10540 (C.D. Cal. Dec. 28, 2011) (consent order).

  [3] United States Department of Justice, Office of Public Affairs, “Justice Department Reaches $335 Million Settlement to Resolve Allegations of Lending Discrimination by Countrywide Financial Corporation.” Washington, D.C.: United States Department of Justice, 2011.

  [4] United States v. Countrywide Financial Corp., No. 2:11cv10540 (C.D. Cal. Dec. 28, 2011) (complaint). 

  [5] United States v. Wells Fargo Bank, N.A., No. 1:12cv01150 (D.D.C. Sept. 21, 2012) (consent order).

  [6] United States v. Wells Fargo Bank, N.A., No. 1:12cv01150 (D.D.C. Sept. 21, 2012) (complaint).

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