It's Time to End 'Exclusionary Lending'

More than 40 years ago, United States courts began striking down what became known as exclusionary zoning — municipal zoning ordinances that required large lots for homes, thereby driving up the cost of housing and excluding low- and moderate-income families and people of color from residing in those communities.

Today, mortgage lenders have put in place excessively restrictive approval standards that have all but shut the doors to conventional mortgage lending to African-Americans and Latinos. This could be termed exclusionary lending, and it's time for regulators to define and prohibit it.

Five years into the economic recovery, lending to African-Americans and Latinos is at the lowest levels in nearly 15 years. Meanwhile, the population of African-Americans and Latinos in the U.S. has grown by nearly 50% during that time, according to our analysis of data from the U.S. Census Bureau.

Some try to justify banks' overly restrictive underwriting practices by arguing that borrowers with lower credit scores and those who can only afford lower down payments — groups that often include black and Latino mortgage applicants — are more likely to default, resulting in losses for lenders.

But much of the research upon which that justification is based relies on analyses of pools of layered-risk loans. In other words, these loans did have low down-payment and credit score requirements. But many were also poorly underwritten, high-cost and included risky features such as second liens, high prepayment penalties and unaffordable upward interest rate adjustments.

An impressive body of research exists showing that modestly lower down payments and credit scores do not in and of themselves result in excessive additional defaults. Of course, a loan with a down payment of 20% will perform significantly better, all things being equal, than a loan with a 3.5% down payment. But loans with 3-5% down payments default merely 0.2% more frequently than loans with 5-10% down payments, according to the Urban Institute.

It is disingenuous, unfair and discriminatory to families and communities of color to examine the effects of low down payments and lower credit scores on loan performance through the lens of defective loan products. 

A related issue is that the Fannie Mae and Freddie Mac's lending standards, which dictate most lending criteria in the U.S. today, continue to rely on outdated FICO credit scoring methodologies developed long before the financial meltdown. Fair Isaac, the firm that created FICO scores, has progressed far beyond that model with scoring technology that differentiates for borrowers with thin credit files and distinguishes between unpaid medical debt and other kinds of debt.  VantageScore, another credit scoring model developed jointly by the nation's three largest credit repository agencies, also scores borrowers with short credit histories, allowing it to measure the credit behavior of an additional 30 to 35 million consumers — roughly 10 million of whom are African-American and Latino.

Financial regulators are well aware of the unnecessarily rigid standards being employed by the lending industry, as well as the industry's failure to update its credit risk assessment techniques with available technology. They see the disparate impact this situation is having on people of color. In recent remarks, Federal Reserve chair Janet Yellen called out unnecessarily restrictive mortgage lending practices as a factor holding back the housing recovery.  And last week, Former Fed chair Ben Bernanke shared with an audience of financial sector executives that even he had been denied a refinancing loan.

There are signs that change is underway. Just yesterday, the Federal Housing Finance Agency announced a reduction in the required down payments that loans must have in order to be guaranteed by Fannie and Freddie, as well as some increased clarity for lenders concerned about loan repurchase requests. The Federal Housing Administration has embarked on efforts to reduce so-called lender overlays — additional underwriting requirements above the minimum government standards.

Yet these efforts have been piecemeal, dominated by input from lenders rather than consumers, and agonizingly slow.

Every day that exclusionary lending persists, the vast difference in wealth and credit circumstances between non-Hispanic white households and households of color grows. This gulf is the legacy of decades of discrimination against minority borrowers in the U.S., which for many years was not only sanctioned by government but mandated by federal policies.

In fact, for the majority of the 20th century, people of color were flatly denied access to home loans. In the 1960s and 1970s, access was provided through the FHA but accompanied with excessive amounts of discriminatory pricing and fraud, including shoddy underwriting and inflated appraisals. In the 1990s and the early 2000s, lenders disproportionately peddled high-cost and predatory subprime loans to black and Latino borrowers.

Today, it's back to higher-cost FHA loans (albeit with greatly improved underwriting practices) for blacks and Latinos. Unnecessarily restrictive conventional lending standards are the principal reason that more than 70% of African-Americans and 63% of Latinos receive their mortgage from the Federal Housing Administration or other government-backed sources. While FHA credit isn't predatory, it is extremely costly. Borrowers of color should not be limited to that channel if they qualify for lower-cost conventional credit.

It's long past time to break this cycle of unequal access to the housing finance market. Regulators should take bold action now, setting out clear timetables for solving these problems and establishing meaningful consequences for lenders who practice exclusionary lending.

Jim Carr is a senior fellow with the Center for American Progress. He is also a former executive with Fannie Mae and former chief business officer with the National Community Reinvestment Coalition.