New research from MIT Sloan shows that mortgage lending in the United States disadvantages Black homebuyers, a disparity that amounts to $67,320 in lost retirement savings.
The paper, “The Unequal Costs of Black Homeownership,” examined factors that lead to higher annual costs for mortgage interest, mortgage insurance premiums, and property taxes for Black homebuyers in the U.S.
“There is significant variation in mortgage rates driven by a host of factors, all of which negatively impact African American borrowers,” the paper states. “These inequities make it impossible for Black households to build housing wealth at the same rate as white households.”
The inequities total $13,464 over the life of an average loan, the research shows. If those extra costs to African Americans were eliminated, the $130,000 Black-white gap in liquid savings at retirement would drop by half, according to the paper, which analyzes the cost differences and recommends how such inequities can be addressed.
The findings did not surprise Teri Williams, president and chief operating officer of OneUnited Bank, the largest Black-owned bank in the U.S.
“This research quantifies what we have experienced,” Williams said. “It's one of those things that you sort of know, but to see it quantified like this is very, very powerful, and at least for me personally, it is validating.”
The paper is part of a report from the National Association of Real Estate Brokers on the State of Housing in Black America. The report was co-authored by executive director of the MIT Golub Center for Finance and Policy; Michelle Aronowitz, former deputy general counsel for enforcement and fair housing at the Department of Housing and Urban Development; and Jung Hyun Choi, a researcher with the Housing Finance Policy Center at the Urban Institute in Washington.
Among some of the paper’s conclusions:
- Black homeowners pay higher mortgage rates at origination amounting to an average of $250 per year, or $11,000 in lost retirement savings.
- Black homeowners continue to pay higher interest rates post-origination. A lack of access to refinance opportunities results in $475 per year in extra costs, or nearly $20,000 in lost retirement savings.
- Black homeowners pay more in insurance premiums, an annual cost of $550, or $23,000 in lost retirement savings.
- Black homeowners pay higher property taxes. Earlier research found that Black homeowners bear a 13% higher property tax burden than white homeowners in the same jurisdiction. By the MIT researchers’ calculation, a black homeowner pays approximately $390 more per year, using a median home value of $207,000.
One proposed solution: a shift in risk assessment
A major reason why Black homeowners pay higher mortgage rates is that mortgage loans use risk-based pricing, which distributes risk unevenly based on factors of individual borrowers, rather than pooled-risk pricing, which pools risk among all borrowers. Risk-based pricing is based on the borrower’s credit score and the amount of their down payment — both of which are typically lower for Black homebuyers. The lower the credit score and the smaller the down payment, the higher the risk, and thus the higher the interest rate.
Although the mortgage industry evolved over the years to use risk-based pricing, “it doesn’t have to be that way,” said Golding, a former head of the Federal Housing Administration.
If mortgage rates were based on pooled risk, then much of the disadvantage to Black Americans would disappear, while still allowing the mortgage industry to remain profitable, he said.
“Given that risk-based pricing appears to be penalizing the Black community, why aren’t there rules to address this?” Williams asked. “We should be asking why they aren’t using pooling rather than individual credit characteristics. It has just been accepted as sacrosanct.”
Mortgage insurance fees are another form of risk pricing that disproportionately affects Black homeowners. Parents or other family members are often the source of down payment money for first-time homebuyers, a resource that is typically less available for Black buyers, Golding said. If their down payment is less than 20% of the cost of the property, lenders require borrowers to purchase the insurance — adding further to the overall cost of the mortgage.
Alternative policies, including tax credits for first-time homeowners, could “greatly reduce the disparate costs borne by Black homeowners,” the paper states.
Should Fannie and Freddie lead the way?
Golding said the director of the Federal Housing Finance Agency has the power to dispense with risk-based pricing at Freddie Mac and Fannie Mae, the two federally backed companies that buy and repackage mortgages to sell to investors in the secondary mortgage market.
As a government, “We make policy choices all the time about how much we want to pool risk,” Golding said.
Before the Affordable Care Act of 2010, for example, health insurers could deny people private health insurance based on pre-existing health conditions they deemed as creating risk. But the ACA banned the practice, forcing insurers to pool that risk. Another example is the Social Security Administration, which has been based on pooled risk from its start.
While Freddie Mac and Fannie Mae account for a little less than half of all mortgages originated to Black homeowners, pooled pricing would increase their share, “so a change in those policies would have a significant impact,” Golding said.
Still, such a switch could depend on the winds of politics.
“I am not naïve that it would go completely away — the body politic is not there,” Golding said.
Credit risk and prepayment risk
The current system also treats default risk differently than prepayment risk, a situation that penalizes Black borrowers.
Default risk, which is pegged to credit risk, represents the chance that a borrower will default on a loan, which is bad for investors in mortgage-backed securities.
Prepayment risk is the chance that a borrower will pay off the loan early, which can also be bad for investors because it tends to lower profits.
On average, Black borrowers are less likely to prepay than white borrowers, a move that maintains profit for the investor. And yet, even though Black borrowers are debited for their higher default risk, they aren’t given credit for their lower prepayment risk.
“We risk-base price one but not the other,” Golding said. “We price the default option based on risk, but pool the prepayment option.”
OneUnited’s Williams said she found the paper’s findings on prepayments and refinancing particularly interesting. In addition to originating loans, OneUnited buys mortgage-backed securities. Through that experience, the bank has learned that mortgage-backed securities in Puerto Rico tend to have a higher value because they have a longer duration, said Williams.
“People in Puerto Rico are less likely to refinance, so therefore their mortgages stay on the books longer, and the bonds tend to have higher value,” Williams said. “Here, the Black community in general is [also] less likely to refinance, and yet they are not given the benefit of that in pricing.”
To address that disparity, the paper said, lenders should incorporate prepayment rates into their pricing models.
As for refinancing, new financial products could address inequities. One such product — mortgages that automatically refinance when the Federal Reserve lowers interest rates — was the topic of discussion at a recent conference hosted by the Golub Center, Golding said.