Are there any racial prejudices in subscribing to GSE?
A recent syndicated article on Racial Bias from The Markup on Racial Bias, published by ABC news, AP, Market Watch and more, garnered considerable attention from business groups, policymakers and housing advocates with support from some and others attacks. .
The story, “The Secret Bias Lurking in Mortgage Approval Algorithms,” included statements from fair housing activists who concluded that there is “systemic racism” in the mortgage process. But the same story was pushed back by the MBA and the ABA, as good as CHLA, arguing that the data were selective and produced a biased conclusion.
The MBA was clearly agitated by the story to the point that they released a public statement which is on their website and was sent to news link subscribers stating, in part, “from the start we have explained to The Markup that his analysis of HMDA’s data and predetermined conclusions regarding mortgages, ignores several key elements that form the backbone of lending decisions, including credit score and credit history of a borrower.
I was also quoted in the article stating, “This is a relatively new world of automated subscription engines that intentionally may not discriminate but, by effect, probably do. ”
In an effort to unwrap this debate and give at least one more perspective that defends both points of view in different ways, let me highlight why I think there is a level of racial prejudice and discrimination in the way people GSE set the price and underwriting of mortgages, which is likely to push more minority applicants towards a FHA mortgage or maybe end up with no mortgage at all.
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First of all, I dispute the article for several reasons. HMDA data shows results across a variety of variables, including race, but does not show FICO information. Obviously, for anyone in the business this is a big deal given that FICO is a threshold data point that determines mortgage eligibility.
Second, the journalists only examined conventional loans, that is, only loans from Fannie Mae and Freddie mac, and does not include loans from FHA/Virginia/USDA. This is important because the FHA in particular has a much higher mix of successful mortgage loans to minority borrowers. On these two points alone, the MBA and ABA pointed out that the conclusions were flawed because they missed these key points.
The authors argued that the MBA was one of the organizations working to ban the publication of FICO scores in HMDA reports, but I agree with the reasoning of the MBA here. With the items reported to HMDA, had FICO been included in public reporting, the risk of confidentiality would be significantly increased. This does not excuse the authors, however, for at least acknowledging why this piece of data is so important.
Now, with all that has been said, let me explain why I believe, as I said in my quote, “This is a relatively new world of automated subscription engines which in turn. intention may not discriminate but by effect probably do.
GSEs set the base price for their mortgages while the FHA sets theirs. The result here is that borrowers who have FICO scores below, say, 720 with a high loan-to-value ratio (LTV) will often find a better deal by going to the FHA. Where I take issue with the GSE pricing methodology is how they combine loan level pricing adjustments (LLPAs) in addition to basic overhead costs for low down payment borrowers at levels that some declared excessive.
GSEs have private mortgage insurance to protect their losses up to an LTV of around 65%, even with a minimum down payment from the borrower. With private capital protecting losses to almost catastrophic risk levels in the event of default, why then are they charging such exorbitant premiums on top of that coverage?
For example, on a 95% LTV purchase with a FICO of 640, an additional charge of 275bp is added to the base g charge and MI expense. The reason why this is done is simple, believe the GSEs, as stated in the public testimony of FHFA, that the counterparty risk of the IM companies is not sufficient to protect this first loss in a deep recession, as the IM companies can go bankrupt and may not pay the indemnities.
But in recent years, GSEs have established new capital requirements on IM companies to protect against a big event, which has made me wonder why they still haven’t changed the aggressive structure of the company. LLPA to account for this first deep loss coverage. Simply put, many low down payment borrowers face additional costs associated with IM and LLPAs, which will result in higher rates or perhaps require them to resort to FHA. And borrowers with low down payments have higher concentrations of minority applicants, thus contributing in part to refusal rates.
The use of credit scores in underwriting emerged in the mid to late 1990s as the standard for assessing willingness to repay debt. FICO is the standard used for this process and although GSEs claim they use their own credit scoring methodology in their underwriting systems, the lender still uses FICO to set floors, set prices and more.
There are two issues here. Firstly, the GSEs haven’t updated their AUS models with updated FICO models, let alone the fact that they refuse to even ride alternative models such as the advantageous score, which claims to be able to score thousands of dollars. additional borrowers who are now denied access to credit. .
Second, the FICO model does not value the timely payment of rent, utilities, cell phone bills, and other consistent payments made by people who are not counted in a score. While Fannie Mae should be applauded for her recent announcement that she could include rental history in a credit score, this is too recent an announcement to assess effectiveness.
The challenge here is that underbanked Americans who make timely payments but have no credit, or perhaps less than the multiple lines that produce a high FICO score, will have a harder time securing a mortgage. . This has a particularly big impact on Hispanics and African Americans whose scores may be lower simply because their proven repayment history does not match a scoring pattern.
Rule 2 of 3
In January of this year, just before Mark Calabria’s departure, the FHFA, Treasury and GSE finalized an amendment to the Preferred Share Purchase Agreement (PSPA) that did a number of things affecting second homes. , 2 to 4 units, cash sales and more. But in addition, the rule caps purchases from any lender, “at a maximum of 6% of purchase price mortgages and a maximum of 3% of refinance mortgages during the period of 52. weeks can have at least two higher risk characteristics initially: combined loan-to-value ratio (LTV) greater than 90%; debt-to-income ratio greater than 45%; and FICO (or equivalent credit score) less than 680 .
This rule remains in effect today. This 2 out of 3 factor rule will clearly have a greater impact on first-time homebuyers and minorities who are more likely to hit two or more of these caps at higher rates than non-Hispanic white borrowers.
Many argue that all is well, that GSEs are quasi-private companies and have set standards based on their view of risk, and that the FHA, VA, and USDA can help provide options if a borrower does not qualify. for a conventional mortgage. I am not here to argue for or against this argument. But none of this changes the outcome. The effect of some of these policies will produce a selection bias in terms of results.
Earlier this year, a Harvard Joint Center for Housing Studies publication found that black borrowers are charged higher rates for all income levels. In the research article, they acknowledged that “many other factors affect interest rates, including wealth, debt, credit rating, down payment, mortgage amount and term.” But the research also concluded that “Black homeowners have encountered systemic barriers to homeownership and wealth-building opportunities that have limited their ability to access credit, which is a key element in qualifying for lower rates. ‘low mortgage interest’.
When I read the MBA’s response to The Markup article, I thought it was a classic response from the trade association that represents the industry, and reading their comments, j I agreed with the concerns I expressed at the start of this commentary. But I would argue that the gap between homeownership rates by race, credit scoring methodologies, and pricing structures should be an area where industry leadership aligns with advocates of. consumers to advocate for change.
When I started my career as a loan officer, there was no credit score. The philosophy was that no credit was not necessarily bad credit and that underwriters could use their judgment in approving a loan. The problem is that the old process also led to racial prejudice. Technology and scoring color the decision-making process. But that doesn’t mean it’s not without flaws. There should be as much effort in exposing these flaws as there is in defending the industry from the points raised in this story.
David Stevens has held various positions in real estate finance, including senior vice president of single family at Freddie Mac, executive vice president at Wells Fargo Home Mortgage, Assistant Secretary of Housing and Commissioner of the FHA, and CEO of the Mortgage Bankers Association.
This column does not necessarily reflect the opinion of the editorial staff of HousingWire and its owners.
To contact the author of this story:
Dave Stevens at [email protected]
To contact the editor responsible for this story:
Sarah Wheeler at [email protected]