When Jeweline Simmons needed a home-improvement loan in 1999, she went to Shelter Mortgage in East St. Louis, Ill., thinking the broker would get her the lowest interest rate possible. She qualified for a 9.8% rate, but she wasn't told that. Instead, Shelter steered her to a loan at 10.7%. Its reward for this tidy piece of salesmanship: a $604.50 payment from lender EquiCredit Corp. (BAC), according to U.S. District Court documents. "I was rushed through some paperwork without knowing what was going on," Simmons says. Only after she had fallen behind on payments and contacted a lawyer did she learn that she was paying too much. She sued Shelter and EquiCredit, which couldn't be reached for comment, and settled out of court.
Battles over lending to low-income, often minority, home buyers used to be about access to credit. Now they're about access to affordable credit. "It's not whether you get the loan, it's the price of the loan," says Kevin Stein, associate director of the California Reinvestment Coalition, an advocacy group. Over the past decade lenders have devised ways to grant mortgages to millions of people with poor credit who wouldn't have qualified before, driving U.S. home ownership to record levels. But those borrowers pay higher rates to compensate lenders for taking on more risk. As the value of these so-called subprime loans has nearly quadrupled since 2000, critics have questioned whether the high rates are justified.
The Federal Reserve wants answers. It has long required lenders to disclose the race, gender, and neighborhood of borrowers to anyone who asks. Now it is upping the ante. As of Mar. 31 lenders must also disclose the interest rate charged on each mortgage if it is three percentage points or more higher than the yield on Treasury bonds, or five points higher for second mortgages. This will help researchers see "if, in fact, differences in rates are truly driven by differences in risks and costs and not tainted by discrimination," said Fed Chairman Alan Greenspan in a speech on Mar. 11.
Ignoring the Scores?
The data will add fuel to an already fiery debate. Advocacy groups are expected to seize upon the new numbers as more evidence that lenders rip off low-income home buyers, even if they don't actively discriminate against them. Critics point to a 2004 study by Freddie Mac (FRE) showing that 38% of subprime borrowers in 2001 had credit scores that qualified them for a prime rate. The study didn't look at the other variables that determine rates. Freddie Mac believes the percentage of subprime customers who should have received prime-rate loans is probably no higher than the low teens.
Lenders are bracing for a public relations onslaught. They argue that their computerized, color-blind models price the risk of each mortgage as accurately as possible. "The data [that have been made public] don't take into account all the factors that go into making a pricing decision on a mortgage loan," says Anne C. Canfield, executive director of the Consumer Mortgage Coalition, an industry group. Lenders argue that disclosing credit scores, income-to-debt ratios, and other details would compromise their customers' privacy and reveal proprietary underwriting methods.
Legislatures and law enforcement aren't waiting for the new data. Since 1999 some 31 states have reined in the subprime-loan market by measures that ban prepayment penalties and restrict the repeated refinancing of loans with ever-higher rates and fees. In Congress two recent bills seek to set national subprime lending standards (BW -- Apr. 4). On Feb. 23 the nation's largest subprime lender, Orange (Calif.)'s Ameriquest Mortgage Co., said it is "in discussions" with authorities in 25 states over its lending practices. The company declines to comment further.
Closer scrutiny hasn't discouraged some of the country's biggest banks from getting into the fast-growing business, long the exclusive province of specialized subprime lenders. Citigroup (C) ranked eighth in issuing subprime mortgages last year, according to newsletter Inside B&C Lending. Also in the top 20 were JPMorgan Chase (JPM), Wells Fargo (WFC), and Washington Mutual (WM). The attraction: profit margins that are still slightly better than those on prime loans because of inefficiencies in the market, says Doug Duncan, chief economist at the Mortgage Bankers Assn. Subprime lending "is not a perfect market, but it's getting more efficient," he says, thanks to competition and better models.
The discretion mortgage brokers and lenders have in setting rates and fees leads to inefficiencies. Lenders offer brokers, who handle about 65% of mortgages, incentive payments to send high-priced loans their way. "When the broker is compensated on the price of the loan, he has an incentive to squeeze the highest interest rate he can get away with," says Ruhi Maker, a senior attorney at the Public Interest Law Office of Rochester, N.Y.
That's just the kind of problem the Fed aims to understand with the new disclosure rules. If the data hint at unfair pricing, lenders may have to take a good, hard look at their methods.
By Justin Hibbard in San Mateo, Calif.