The blog of the Urban Institute
October 13, 2021

Closing the Homeownership Gap Will Require Rooting Systemic Racism Out of Mortgage Underwriting

The 30 percentage-point homeownership gap between Black and white households is wider today than it was in 1960, when explicit housing discrimination was still legal. Applicants of color experience higher mortgage denial rates than white applicants, which helps sustain the gap.

Lenders often attribute this disparity to the poorer average credit characteristics of applicants of color rather than to the consequences of discrimination.

This perspective overlooks the fact that racial disparities pervade the credit indicators that drive lending outcomes. The three Cs that determine mortgage access—credit, collateral, and capacity—reflect the results of a long history of racial discrimination in US public and private institutions. Thus, relying on these lending criteria reinforces disparities that discrimination created, though the metrics don’t explicitly include race.

Unjust practices created an architecture of wealth extraction from communities of color and produced racial gaps in lending that will persist absent intervention. Closing the racial homeownership gap will require more than eradicating discriminatory lending practices; it will require removing systemic racism from mortgage underwriting.

The three Cs

Credit. Lenders use credit histories and scores to determine an applicant’s likelihood of repaying their loan. But for decades, banks denied communities of color access to the services that allowed white people to build credit, making people of color less likely to satisfy lenders’ credit requirements.

Redlining—the process by which the Federal Housing Administration and banks deemed neighborhoods of color unfit for investment and effectively barred people of color from homeownership—is perhaps the most well known of these practices, but it is far from the only one.

Consequently, people of color had less access to the 30-year mortgages, revolving credit, and Federal Deposit Insurance Corporation–backed bank accounts that underpinned the growing middle class. In their absence, costlier, riskier, and less regulated alternatives filled the void, using business models that often trapped people in cycles of debt.

Today, despite improved financial access, Black households are more than five times as likely as white ones to be unbanked. People without bank accounts pay up to 10 percent of their income just to access their money. As a result, Black households are more likely to be credit invisible or unscorable. And for those with credit histories, scores are lower on average than white households’ scores, even when comparing people with similar incomes.

People of color face greater barriers in acquiring mortgages, which helps sustain the racial homeownership gap.

Collateral. Exclusion has also drained property (collateral) values and diminished access to equity accumulation in communities of color. Even after federal legislation made redlining and banking discrimination (PDF) illegal, suburban life—and the wealth-building opportunities that come with it—remained unattainable for most families of color in the second half of the 20th century.

Meanwhile, public programs reshaped the urban built environment. All levels of government disproportionately located construction of infrastructure projects and industrial sites near urban communities of color, exposing them to environmental hazards, tearing down neighborhoods, and displacing residents.

Proximity to these sites lowered the values of nearby homes, and exclusion from white neighborhoods limited housing options for many residents of color. These conditions enabled speculators to sell dilapidated homes needing expensive repairs at elevated prices. Concurrently, policymakers directed amenities and resources away from communities of color.

Together, these factors reduced property values and increased the risk of foreclosure in communities of color, both of which diminished returns on homeownership. And smaller returns meant smaller inheritances for children of color, leaving them without an important resource for first-time homebuyers.

Owning a home still does not provide the same economic boost for Black homeowners as it does for white homeowners. Today, homeowners of color have less valuable homes, higher relative mortgage debt, and higher user costs of homeownership. Compounding these trends, Freddie Mac recently found that appraisers continue to undervalue properties in communities of color.

Capacity. Capacity indicators measure borrowers’ financial resources, including down payment funds, cash reserves, and the ratio of their monthly debt payments to total income. The discriminatory practices that influence credit and collateral have the same effect on capacity: they stripped wealth from people of color, saddled them with debt, and restricted their resources available for down payments.

At the same time, employment discrimination institutionalized racial income disparities. Foundational New Deal labor programs like Social Security and unemployment insurance didn’t apply to agricultural and domestic workers, two labor forces composed disproportionately of people of color. Further, explicit hiring discrimination was legal until 1964, and even since its prohibition, it still limits employment opportunity. Research indicates that discrimination has remained steady over the past 25 years, contributing to the $50,000 income gap that still exists between white and Black workers.

And the financial system continues to disproportionately harm people of color: the Great Recession lowered the median wealth of Black families by more than 50 percent—three times the decline for white families.

How can policymakers and the housing industry make homeownership more equitable?

This history, though incomplete, reveals the indelible influence of racism on wealth and debt—along with the measures of credit risk that we derive from them. And because of differences in intergenerational wealth transfers, the gap between Black and white households persists: the average white household held seven times more wealth than the average Black household in 2019.

Racial disparities in underwriting criteria reflect this gap. The median credit score for Black people is 629, nearly 100 points lower than the median score for white people. Similarly, according to 2020 Home Mortgage Disclosure Act data, the median debt-to-income and loan-to-value ratios for Black mortgage applicants are 40.0 and 69.7 percent, respectively, compared with 33.0 and 64.5 percent for white applicants.

Policymakers and industry have the responsibility and the tools to disentangle credit risk determinations from the influence of systemic racism. They could consider the following steps:

  • Include rental and other monthly payments in credit score calculations, which would lift credit scores in communities of color.
  • Offer targeted down payment assistance, which would help borrowers acquire less debt and lower their loan-to-value ratios and monthly payments, thereby boosting their capacity.
  • Embrace alternative models like community land trusts, which facilitate stable homeownership for borrowers whose financial history may otherwise disqualify them.
  • Eliminate price differentials based on credit and down payment.
  • Encourage lending to people of color via Fannie Mae and Freddie Mac’s Duty to Serve and equity plans.
  • Adopt better protections for homeowners who experience income shocks like unemployment or illness.
  • Streamline refinancing to enable borrowers to accelerate equity accumulation and lower expenses.
  • Implement special-purpose credit programs to make homeownership accessible to those the financial system has historically denied access to opportunity.

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