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Higher-Priced Home Lending and the 2005 HMDA Data

Robert B. Avery, Kenneth P. Brevoort, and Glenn B. Canner, of the Division of Research and Statistics, prepared this article. Caitlin G. Coslett and Sean M. Wallace provided research assistance.

Since 1975, the Home Mortgage Disclosure Act (HMDA) has required most mortgage lending institutions with offices in metropolitan areas to disclose to the public information about the geographic location and other characteristics of the home loans they originate or purchase during each calendar year. Disclosure of home-lending activity is intended to help the public determine whether institutions are adequately serving their communities' housing finance needs, to facilitate enforcement of the nation's fair lending laws, and to guide public- and private-sector investment activities. Although the act is intended to help achieve important public policy goals, the law itself does not include mandates or restrictions on lending--that is, it does not direct lenders to make loans to particular areas or persons, nor does it direct them to make certain kinds of loans or to refrain from certain loan terms or practices.

Taken together, the nearly 8,850 lenders currently covered by the law account for an estimated 80 percent of home lending nationwide. Consequently, HMDA data likely provide a representative picture of most home lending in the United States. The information thus provided is rich, but it is limited: The data reveal a great deal about what the lending patterns are but relatively little about what causes the patterns. Nonetheless, by drawing attention to these patterns, the data promote further analysis and discussion that can deepen understanding of their causes and encourage marketplace efficiency by fostering competition.

The Congress has amended HMDA on several occasions to extend the reach of the law to more institutions and to expand the types of information that must be disclosed. The most sweeping legislative amendments occurred in 1989; they required the disclosure of application and loan-level information for home loans, including the disposition of applications and the income, sex, and race or ethnicity of the individuals applying for credit. Analysis of this information has prompted widespread public discussion about the fairness of mortgage lending decisions, as the disclosures revealed wide disparities in the rates of approval of loan applications across racial and ethnic lines. The disclosures triggered debate about the proper interpretation of the data and about the meaningfulness of the disparities in the disposition of loan applications and in lending patterns.¹ The disclosures also led many lenders to strengthen their fair lending compliance programs and to expand their outreach to underserved communities.

Periodically, the Federal Reserve Board reviews each of the regulations that it promulgates, including Regulation C, which implements HMDA.² As a result of the Board's most recent review of Regulation C, a number of important changes were made to the reporting requirements, changes that substantially increase the types and the amount of information made available about home lending (for details, refer to the appendix).³ The Board stated that the revisions were intended to keep the regulation in step with recent developments in mortgage markets and with the revised standards of classification for the collection of information on race and ethnicity as established by the Office of Management and Budget (OMB).⁴

The 2004 HMDA data, the first to reflect the recent revisions to Regulation C, were released to the public by individual lending institutions in the spring of 2005. In September 2005, the Federal Financial Institutions Examination Council (FFIEC) made publicly available various summary reports (statistical tables) pertaining to each lender and lending activity in each metropolitan statistical area, along with a comprehensive data file that included all the reported information (except the dates of loan applications and of credit decisions).⁵ At that time, the staff of the Federal Reserve Board prepared the first comprehensive assessment of the expanded data, which was published as an article in the Federal Reserve Bulletin.⁶

The most important change made to Regulation C is the requirement that lenders disclose pricing information for loans with prices above designated thresholds; such loans are referred to here as "higher-priced loans." The new pricing data allow a better understanding of lending activity in the higher-priced segment of the mortgage market, a market segment that has grown substantially over the past decade or so in response to improvements in information processing technology and in the ability of lenders to measure and price for credit risk.

Greater understanding of the market and an improved ability to monitor the activities of individual lenders in the higher-priced market segment are important because the expansion of such lending, though affording some consumers greater access to credit, has been accompanied by a variety of concerns. The concerns relate to the appropriateness of loan terms and lending practices, constraints on consumer shopping and on access to the full range of credit opportunities, the competitiveness of the higher-priced market, and the potential for unequal treatment of borrowers on the basis of race, ethnicity, or some other characteristic protected by law.

A review of the 2004 HMDA data found that, in the aggregate, less than one-fifth of borrowers took out higher-priced loans. However, the data also showed that the incidence (measured as the proportion of borrowers) of higher-priced lending varied substantially across racial and ethnic lines: Blacks and Hispanic whites were more likely, and Asians less likely, to have received higher-priced loans than non-Hispanic whites. Information included in the HMDA data on borrower or loan characteristics, such as income and amount borrowed, was insufficient to account fully for the variation in loan pricing across groups. Many factors routinely used by lenders to underwrite and price loans--including loan-to-value (LTV) ratios, debt-to-income (DTI) ratios, and measures of borrower credit history (for example, a credit history score)--are not included in the HMDA data and, consequently, cannot be accounted for in an analysis of pricing differences that relies on these data alone.

Differences in loan-pricing outcomes, such as those revealed in the HMDA data, have increased concern about the fairness of the lending process. Lenders are responsible for ensuring compliance with fair lending laws, and the expanded HMDA data may both encourage and facilitate improved compliance efforts. The regulatory agencies charged with enforcement of the fair lending laws also use the expanded data to facilitate enforcement activities.

This article reviews the 2005 HMDA data, which have just been released to the public. The 2004 article covered a wide range of topics, including ways in which the expanded data might be used to aid fair lending enforcement, but this article is more limited: The focus here is primarily on the loan-pricing aspects of the data, including those that permit an assessment of the effects of the changing interest rate situation in 2004 and 2005 on the disclosure of higher-priced lending. To identify the effects on lending patterns of changing interest rates, the analysis presented here uses adjusted sets of the 2004 and 2005 HMDA data in an attempt to distinguish the loans that exceeded the pricing thresholds solely because of a changed interest rate situation from other higher-priced loans. This section of the analysis relies on monthly surveys of loan terms and pricing conducted by Freddie Mac and the Federal Housing Finance Board to help gauge the effects of changing interest rates over the period.

The analysis indicates that the substantial narrowing of the difference between short- and long-term interest rates in 2005 compared with 2004 not only increased the overall share of reported loans that exceeded the pricing thresholds established by Regulation C but also affected to some degree the gap in loan-pricing outcomes among groups of borrowers sorted by their race or ethnicity.

The analysis further reveals that changes in interest rates substantially affected the types and the proportions of loans that exceeded the price-reporting thresholds. Because of a combination of (1) the procedure specified in Regulation C for determining which loans are higher priced and (2) the rules governing how annual percentage rates (APRs) are calculated for adjustable-rate loans, adjustable-rate loans were much more likely than fixed-rate loans with similar risk profiles to be below the HMDA price-reporting thresholds in 2004 but were about as likely as fixed-rate loans to be above the threshold by the end of 2005. One consequence of this changed relationship is that certain populations--such as those residing in the western part of the country--that used adjustable-rate loans relatively more often than fixed-rate loans likely witnessed a relatively larger increase in reported higher-priced lending in 2005.

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Loan Pricing in the Mortgage Market

Over the past decade or so, the mortgage market has changed markedly. Before that, mortgage lenders offered consumers a relatively limited array of loan products at prices (interest rates, points, and fees) that varied not by the creditworthiness of the borrower but by loan type (for example, conventional or government-backed), loan characteristic (for example, amount borrowed, term to maturity, or LTV ratio), type of structure securing the loan (for example, traditional "site built" home or factory-manufactured unit), and ownership status (owner-occupied or nonowner-occupied). Effectively, borrowers either did or did not meet the underwriting criteria for a particular product. Those who met the criteria paid about the same price; those who did not were denied credit.

Advances in technology, better access to information on the credit histories of individuals, increased competition, and the maturation of a robust secondary market for loans representing the full spectrum of credit risks have helped spur remarkable changes in the mortgage market. Most prominent has been credit pricing based explicitly on risk. Today, much more so than in the past, differences in the creditworthiness of different borrowers can lead to different prices for the same product.⁷ Applicants who are less creditworthy or who are unwilling or unable to document their creditworthiness or income are increasingly less likely to be turned down for a loan; rather, they are offered credit at higher prices.⁸ Explicit risk-based pricing has expanded opportunities for homeownership and has allowed individuals, including those who are otherwise credit constrained, to more readily purchase homes or to borrow against the equity they have accumulated in their homes.

Borrowers in the higher-priced market generally fall into one of two market segments--"subprime" or "near prime." Individuals in the subprime category typically pay the highest prices because they pose greater credit or prepayment risk or are otherwise more costly to serve. In practice, the dividing line between these two "nonprime" market segments can be somewhat amorphous, as can the line between the prime and nonprime markets. Moreover, the thresholds that separate these market segments can change as market interest rates move, as lenders' appetites for interest rate or credit risk change, and as technological improvements allow for more-precise risk assessment.

Estimates of the annual volume of nonprime lending vary, but all sources agree that the nonprime market segment has grown substantially in recent years. One source estimates that from 1994 to 2005, the dollar volume of subprime loans increased from about $35 billion to more than $600 billion. Further, subprime lending is no longer a minor portion of the mortgage market. Subprime loans are estimated to have accounted for 20 percent of all mortgage originations in 2005, up from less than 5 percent in 1994.⁹

Concerns about Loan Pricing

As price flexibility has emerged in the mortgage market, so have concerns about the fairness of pricing outcomes. Such considerations generally fall into three broad categories: In the first category are concerns about possible discrimination based on the race or ethnicity of the borrower. These concerns are heightened because, for some loans, prices are determined on an individual basis and not strictly according to credit risk, cost factors, or competitive conditions.

In the second category are concerns about whether borrowers in the higher-priced segment of the loan market have sufficient resources (for example, time, information, and financial experience) to shop effectively for the loan terms most appropriate to their circumstances. These concerns relate to both borrower and lender behavior. For example, some borrowers may not shop or negotiate for the best available rates and terms because they need funds immediately and are focused primarily on the amount they can borrow and the size of the monthly payment, not on the interest rate, fees, or other loan features. And some lenders may engage in aggressive "push" marketing that may confuse borrowers about the cost and terms of loans.

Finally, concerns have been raised about whether competition is adequate to ensure that borrowers in the higher-priced segment of the loan market are provided with the full range of credit opportunities. Some believe that prime-market lenders are not present, or do not offer or promote their prime products sufficiently, in certain geographic markets, including neighborhoods that have larger minority populations. In this view, limited access to prime lenders and the products they offer diminishes the opportunities for borrowers in affected communities to obtain lower-priced loans. These concerns are extraordinarily complex and beyond the scope of this article. The Federal Reserve Board's recent hearings on home equity lending sought to collect more information about these and other concerns raised by the rapid growth of the higher-priced segment of the market.¹⁰

Determining What Pricing Information Is Reported

In 2002, the Federal Reserve Board amended Regulation C to require the disclosure of pricing information for higher-priced loans. In establishing the loan-pricing disclosure rule, the Board sought to select thresholds that would limit regulatory burdens by focusing data reporting on only those loans in the higher-priced segment of the market.¹¹

Specifically, for loans with spreads above designated thresholds, revised Regulation C requires the reporting of the spread between the APR on a loan and the rate on Treasury securities of comparable maturity. The thresholds for reporting differ by lien status: 3 percentage points for first liens and 5 percentage points for junior, or subordinate, liens.¹² The different thresholds for first and junior liens are intended to reflect differences in the credit risk and other features of the loans in these two different markets. To better interpret the reported pricing information, the Board has also required institutions to report the lien status for each loan.

In limiting the reporting of price information to only the higher-priced segment of the market, the Board weighed the costs and benefits of more-expansive data collection and reporting and determined not to adopt more-expansive reporting requirements. The Board also chose to refer to loans with prices that exceed the reporting threshold as "higher-priced loans" rather than as "subprime loans." The correspondence between subprime loans and loans with prices exceeding the threshold is not precise. The Board's regulation sets the price-reporting thresholds in such a way that the number or proportion of loans reported as higher priced can vary from year to year even if the size and the share of the subprime market have stayed the same.

Reasons for Loan-Price Variation

Mortgage pricing is complex and reflects a wide range of factors. Many of these factors are easily quantifiable and objectively measured. Some, however, are less readily quantified--for example, the extent of negotiations, if any, between lender and borrower. The expanded HMDA data include few of the factors that may help explain variations in the prices of reported loans. Even if all of the readily quantifiable factors were included in the data, they would not necessarily fully explain loan pricing because some factors are difficult to measure.

Important factors not included in the HMDA data include the costs of raising the funds to be lent; considerations related to credit risk, such as those reflected in the borrower's credit history, LTV ratio, or DTI ratio; prepayment risk (the risk that a loan will be prepaid before the term of the loan); overhead expenses, such as those related to providing offices and to compensating staff for finding prospective borrowers and underwriting loans; loan-servicing costs; and possibly the extent of negotiations between creditor and borrower. Market conditions and competition also bear on pricing, as local economic conditions--including, importantly, those of local housing markets--can influence the demand and supply of credit.¹³ Finally, the legal situation in a state, including foreclosure rules, may affect loan pricing by constraining to a greater or lesser degree the ability of lenders to recover and dispose of the collateral used to back loans that are in default.

Mortgages are typically priced at a spread above the yields on Treasury securities or on other, similar instruments or indexes of funding costs that correspond to the time a loan is expected to be outstanding. Each of the factors noted earlier may influence the magnitude of the spread. Elevated credit risk for loans in the higher-priced mortgage market results in substantially higher default and foreclosure rates and costs and, consequently, in higher price levels. Prepayment risk is also greater for higher-priced loans not only because borrowers in the higher-priced market have an incentive to refinance when interest rates fall (as do borrowers in the lower-priced market segment) but also because they have an incentive to prepay when their credit history improves to the point that they qualify for lower-priced credit.¹⁴ Because credit and prepayment risks are higher for loans in the higher-priced segment of the market, such risks tend to vary more in this market segment.

Lenders active in the higher-priced market may also face a cost structure different from that faced by lenders focused on the lower-priced segment of the market. Lenders focused on the higher-priced market segment may face steeper funding costs, may incur higher marketing expenses, and may have a much lower flow-through rate--that is, the number of applications processed to successfully extend a loan may be higher for such lenders than for lenders that deal primarily with borrowers with few credit problems or with the ability to make large down payments.

Discretionary, or Flexible, Pricing

Some creditors provide their loan officers and agents working on their behalf (for example, mortgage brokers or loan correspondents) with rate sheets that indicate the creditors' baseline prices by loan product (for example, conventional loans of various types), owner-occupancy status, loan characteristic (for example, amount of loan, prepayment penalty option, term to maturity, or LTV ratio), and borrower creditworthiness (as reflected in, for example, a credit history score or DTI ratio).

Rate sheets vary across lenders. For some lenders, the rate on the sheet is a "sticker" price; for others, it is the minimum accepted price; and for still others, it is the actual target price. Some lenders have a single rate sheet for the entire organization (for each loan product); others have different rate sheets for different geographic markets that reflect local market competition and costs. Rate sheets can change daily with changes in basic economic conditions, such as market interest rates.

Loan rates paid by borrowers can deviate from the interest rates shown on sheets for many reasons. For example, the rates on the sheets may not reflect differences in loan origination costs. Also, in some cases, loan officers and brokers are allowed to deviate from prices on rate sheets as market conditions, including the extent of competition, warrant or allow. Deviations may also occur because of negotiated outcomes. Loan officers or brokers may benefit from pricing flexibility through higher compensation by obtaining a price above the rate stated on a rate sheet (or above prices obtained by others).

Borrowers differ in their propensity to negotiate--for example, borrowers with less experience in the mortgage market, such as first-time homebuyers, may be less likely than experienced borrowers to negotiate. These differences in negotiating propensities may be correlated with race, ethnicity, or sex. For example, minorities are disproportionately first-time homebuyers.

Discretionary, or flexible, pricing may be a legitimate business practice. Properly developed, monitored, and administered, discretionary pricing programs may help to ensure that markets allocate resources in an efficient way. However, when loan officers have latitude in deviating from rate sheets or in determining which rate sheet applies to each borrower, the lender runs the risk that differential treatment on a basis prohibited by law may arise. For this reason, the Interagency Fair Lending Examination Procedures provide that discretionary pricing should be considered an examination "risk factor" when a lender's risk for engaging in pricing discrimination is evaluated.¹⁵

Variations in Loan-Processing Channels

The delivery channels through which borrowers obtain loans vary across lenders, and such variation may affect loan pricing. On the one hand, underwriting and pricing may be centrally controlled even though applications for credit may begin through different channels, such as the Internet, the mail, or a visit to a bank office. On the other hand, in complex financial organizations with numerous bank branches, multiple affiliates (both bank and nonbank), decentralized loan production offices, and third-party brokerage operations, each application may be subject to a different underwriting and pricing regime depending on its point of initiation.

The 2004 HMDA pricing data suggested that the delivery channel through which a borrower obtains a loan may matter. For example, the incidence of higher-priced lending was significantly higher for borrowers who lived outside the assessment areas of lenders covered by the Community Reinvestment Act of 1977 (CRA) than for those who lived inside these areas.¹⁶ The HMDA data do not provide a reason for this pattern, but several explanations that warrant further research are possible. For example, the difference may be due, at least in part, to a reliance on different delivery channels for loans within and outside these lenders' assessment areas.

Differences in the incidence of higher-priced lending across groups may also arise if different channels tend to serve different customer groups. For example, mortgage brokers or loan correspondents that originate loans on behalf of a depository institution (commercial bank, savings association, or credit union) may focus on the subprime market, while the depository institution may offer a broader range of mortgage products through its retail branch network. If mortgage brokers or loan correspondents that focus on the subprime market tend to work disproportionately with borrowers from minority neighborhoods, then the depository institution's overall pricing pattern may show a higher incidence of higher-priced lending for minorities than for whites.

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General Findings from the 2005 HMDA Data

For 2005, lenders covered by HMDA reported information on roughly 30.2 million home-loan applications--11.7 million for purchasing one- to four-family homes, 15.9 million for refinancing existing home loans, 2.5 million for improving one- to four-family dwellings, and the balance for loans on multifamily dwellings for five or more families (table 1). ¹⁷ These applications resulted in some 15.6 million loan extensions. Lenders also reported information on about 5.9 million loans they purchased from other institutions and on some 397,000 requests for pre-approvals of home-purchase loans that either were turned down by the lender at the time the pre-approval was sought or were granted but not acted on by the applicant (data not shown in table). The total number of reported applications and purchased loans increased about 2.8 million, or 7 percent, from 2004; most of the increase was for applications for home-purchase loans. The number of applications for loans to refinance an existing loan fell about 1 percent, likely because of an increase in interest rates in 2005.Skip table 1

From the 2005 HMDA data, the FFIEC prepared disclosure statements for 8,848 HMDA-reporting institutions--3,904 commercial banks, 974 savings institutions, 2,047 credit unions, and 1,923 mortgage companies (table 2). Of the mortgage companies, 70 percent were independent entities--that is, institutions that were neither subsidiaries of depository institutions nor affiliates of bank holding companies (data derived from table). The disclosure statements consisted of 78,193 distinct reports, each covering the lending activity of a particular institution in each metropolitan statistical area (MSA) in which it had a home or branch office (table 1, last column). The total number of reporting institutions was little changed from 2004, as was the distribution of reporters by type of institution.skip table 2

Lender Specialization

Mortgage companies, as distinct from depository institutions, received more than 60 percent of all the home-loan applications reported in the 2005 HMDA data, although such companies accounted for only about one-fifth of the reporting institutions (table 3). Among mortgage companies, those affiliated (either directly or indirectly) with a depository institution tended to be very active lenders: The 576 mortgage company affiliates processed 24 percent of the applications in 2005.Skip table 3

Different types of lending institutions tend to specialize in different types of home loans, although less so than in the past. The most notable change has been the diminished role that mortgage companies play in originating government-backed loans. In 2005, mortgage companies accounted for nearly 64 percent of government-backed originations. As recently as 2002, their share of originations of this type had been 83 percent. Depository institutions extended 71 percent of reported home-improvement loans and about 88 percent of multifamily loans (data not shown in tables). Commercial banks accounted for about half the loans for manufactured homes in 2005.

Activity and Size of Lender

Although the number of lending institutions covered by HMDA is large, most of these institutions, whether measured by asset size or by some measure of lending activity (such as the number of reported applications or loans), are small (table 3). For 2005, 60 percent of the reporting institutions each provided information on fewer than 250 loans or applications, accounting for just 1.6 percent of all the reported data. At the other end of the spectrum, 6 percent of reporting institutions each provided information on 5,000 or more loans or applications, but these few highly active lenders accounted for 88 percent of all the reported data.

Asset size is available only for depository institutions. Asset size and lending activity are highly correlated. For example, the 707 depository institutions with assets of $1 billion or more reported 86 percent of all applications reported by depositories, whereas the 4,236 HMDA-reporting depository institutions with assets of less than $250 million accounted for only about 5 percent of the applications (percentages derived from table 3).

Many HMDA reporters are affiliated with each other. If individual HMDA reporters are aggregated to their highest level of corporate organization (such as a bank holding company), the concentration of mortgage lending nationwide is evident. The twenty-five organizations reporting the largest number of applications and loans accounted for 54 percent of the 2005 data, a proportion essentially unchanged from 2004 (data not shown in tables).

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Disposition of Applications, Selected Categories of Loan Products, and the Secondary Market

The HMDA data provide opportunities to categorize applications and loans in a wide variety of ways. For the analysis here, applications were grouped into twenty-five product categories based on loan and property type, purpose of the loan, and lien and owner-occupancy status.¹⁸ For each product category, information is provided on the number of total and pre-approval applications, application denials, originated loans, loans with prices above the thresholds, loans covered by the Home Ownership and Equity Protection Act of 1994, and the mean and median APR spreads for loans priced above certain thresholds (table 4).skip table 4