Bias in the Mortgage Approval Process

Nearly two-thirds of a typical American household’s wealth comes from homeownership, making it crucial for prosperity. Since most individuals can’t afford to purchase a home outright, they need to be approved for a loan. This approval process involves a series of steps that will help get them a mortgage.

The lending industry is key for homeownership and is an industry that’s projected to grow. According to Freddie Mac, demand for housing is expected to grow even with the effects of the COVID-19 pandemic. In fact, the agency estimates home sales to reach 6.9 million in 2022 and rise to seven million in 2023, and mortgage origins to grow from $2.1 trillion in 2022 to $2.2 trillion the following year.

Homeownership has historically been influenced by racial, ethnic, and other prejudices. Even in the areas where it has improved, recent studies have characterized the reduction of racial inequality in housing generally as “slow, uneven, and fragile.’ In certain areas, there has been little to no improvement. Events such as the Great Recession of 2008 and the COVID-19 pandemic also diminish minority homeownership rates, particularly for Latinx and Black communities. Other studies suggest LGBTQ+ communities also face challenges when it comes to accessing financing.

Despite the existence of laws that prohibit discrimination in the housing market, studies show that racial bias—particularly in the mortgage approval process—continues to entrench racial segregation and influence the racial wealth gap. This article explores some of the bias that exists in the mortgage lending industry.

Forms of Discrimination

Discrimination of any kind is illegal—even in the lending industry. But that doesn’t mean it never happens.

A comprehensive review of the evidence published by the Urban Institute in 1999 found that minority homeowners in the U.S. faced discrimination from mortgage lending institutions, which took two main forms:

• Differential Treatment: This occurs when qualified minority homeowners are discouraged from taking a loan, denied a loan, or are offered unfavorable loan terms because of their race or ethnicity.
• Disparate Impact: This form of discrimination is present when minority loan seekers are disqualified at a higher rate than whites in a manner that cannot be justified as a business necessity, even when the reasons why this difference exists aren’t immediately obvious.

Mortgage Discrimination and Homeownership

The Fair Housing Act prohibits housing discrimination of any kind. The law was enacted in 1968 and outlawed housing discrimination based on race, religion, gender, family status, disability, and ethnicity. The goal was to ensure access to housing, whether that’s through home purchases or rentals, to everyone.

Despite the law, homeownership rates for Black Americans are still disproportionate compared to those for white Americans. According to Alanna McCargo of the Urban Institute, there’s a large gap in homeownership for racial and ethnic homeowners that continues to grow. “We have not simply failed to make progress; we are losing ground. And we cannot continue to go backward.”

Over 74% of homeowners were non-Hispanic white Americans as of the fourth quarter of 2021. Compare that to 43.1% of Black Americans and 57.6% of all other races, including Asian, Native Hawaiian, and Pacific Islanders, according to the St. Louis Fed.

Black and Hispanic consumers purchased homes during the peak of the housing bubble and were more likely to be offered subprime loans than whites and Asian Americans, even when they qualified for prime loans, according to McCargo, who also stated that their recovery rates were slower than whites.

Disparate Rejection Rates and Segregation

A 2020 meta-study from Northwestern University reported that racial discrimination persisted in mortgage lending. While most forms of discrimination in the housing market declined or ceased (including the most extreme forms, such as lying about the availability of advertised housing units), the authors of the study said that Black and Hispanic borrowers still face disproportionately high levels of rejection.

According to the study, racial gaps in loan denial decreased slightly between the 1970s and 2020, while gaps in mortgage costs remain for Blacks, Hispanics, and Asians. Discrimination like this entrenches racial segregation by pushing those with weak preferences to neighborhoods made up of residents with similar racial backgrounds. This only serves to fuel the racial wealth gap by making it harder for Blacks to actually build wealth.

Other studies also corroborate this finding, including a 2019 LendingTree report, which indicated racial differences in lending rejection rates. According to that report, Black borrowers have the highest denial rates, at 17.4%, and non-Hispanic Whites have the lowest, at 7.9%.

LGTBQ+ couples also face discrimination by those in the mortgage lending industry. These couples faced 73% higher rates of loan rejection than heterosexual couples with similar applications. They also were more likely to be charged higher fees and higher interest rates.

Historical Discrimination and Laws

Discrimination has historically shaped the mortgage approval process in the United States. Some characterize housing inequalities as the lingering hangover of historical inequalities.

The Federal Housing Administration (FHA) encouraged white middle-class homeownership during the 20th century. But the practices it used, including redlining and restrictive covenants, denied minorities access to federally subsidized housing and mortgage insurance.

As noted above, the Fair Housing Act made housing discrimination based on race, ethnicity, and other factors illegal. A follow-up to the 1964 Civil Rights Act, the Fair Housing Act was signed in the days immediately after the assassination of Martin Luther King Jr., who became affiliated with the struggle for fair housing during the 1966 open housing marches in Chicago. According to some, the Fair Housing Act’s main objective was to “curtail discrimination in the housing sector.”

The Equal Credit Opportunity Act (ECOA) of 1974 broadened protections to interactions with places that regularly extend credit, including banks and other institutions that offer home loans. It makes it illegal to discriminate because of race, color, religion, national origin, sex, marital status, age, or use of public assistance.

Housing Discrimination in the Digital Age

The rise in digital applications swept through the financial sector with increasing consumer demand for financial service accessibility, making changes to the way institutions do business. Digital mortgage platforms now make it easier for people to apply for and get approval for mortgage loans. But it also raises some questions about how they address discrimination in the market.

A University of California, Berkeley study found that fintech doesn’t completely remove bias. According to the findings, many show no discrimination in loan rejection rates. But while algorithmic lenders reduce disparities in rejection rates, they did not eliminate “impermissible discrimination.” That’s because they may profile consumers for low-shopping behavior and those who operate in weaker competitive environments. They charged otherwise equivalent Latinx and Black borrowers $765 million more per year for refinancing mortgages.

An investigation conducted by The Markup highlighted how lenders were turning down more people of color for mortgages compared to white applicants in 2019, even though they had the same financial backgrounds. Overall, minority borrowers were 40% to 80% likely to be denied home loans compared to white consumers even when algorithms are at play. The report also highlighted the costs associated with mortgage applications, which are often non-refundable, as being another strike against those who aren’t approved.

The Bottom Line

Homeownership accounts for as much as two-thirds of the wealth of a typical household in the United States. This means the mortgage approval process could be a large hurdle on the road to wealth and stability.

McCargo’s testimony highlighted several changes that she said would improve the situation. Her recommendations included promoting an equitable housing finance system that is sensitive to the fact that minorities are more likely to lack a credit history, as well as an expansion of credit access, an update of credit scoring systems, and modernization of the FHA. McCargo also suggested improving down payment assistance programs, creating a “robust small-dollar mortgage market,” and outreach and counseling for renters and home-ready millennials, among other proposals.