Mortgage Prepayment, Race, and Monetary Policy

Abstract

This paper documents large differences in mortgage prepayment behavior across racial and ethnic groups in the United States, which have significant implications for monetary policy, inequality, and pricing. Using a novel data set that combines administrative data on mortgage performance with information on race and ethnicity, we show that Black and Hispanic white borrowers have significantly lower prepayment rates compared with Non-Hispanic white borrowers, holding income, credit score, and equity constant. This gap is on the order of 50 percent and largely reflects different sensitivities to movements in market interest rates, and was particularly pronounced during QE1. Differences in prepayment speeds result in large disparities between white and minority borrowers in the distribution of rates paid on outstanding mortgages, which widens during periods of low mortgage rates and high refinance volumes. From 2010 to 2014, Black borrowers were paying 30 to 45 basis points more on average than Non-Hispanic whites despite only a small gap of about 5 basis points between the groups at the time of mortgage origination. The large differences in prepayment behavior have important pricing implications, as they suggest that minority borrowers are overpaying for their prepayment option. Our results show that inequality in mortgage markets is larger than previously realized and is exacerbated by expansionary monetary policy.

Racial Differences in Mortgage Refinancing, Distress, and Housing Wealth Accumulation during COVID-19

“…Our data provide insights into why Black borrowers were so much less likely to refinance. We find that during the COVID-19 pandemic, basic patterns documented in earlier research (Gerardi, Willen, and Zhang, 2020) continued to hold. Black and Hispanic borrowers have higher exposure to risk factors such as low credit scores and high loan-to-value (LTV) ratios, and these risk factors inhibit refinancing.…”

“…1 fallen by more than half to 7.0 percent, whereas in March 2021, almost a year after the pandemic started, the Black unemployment rate was still close to 10 percent. 3 The second reason to focus on racial differences in mortgage outcomes is that recent work by Gerardi, Willen, and Zhang (2020) documents significant differences in refinance behavior across racial and ethnic groups. They find that disparities were especially large during periods of expansionary, unconventional monetary policy, such as the quantitative easing (QE) programs adopted by the Federal Reserve to combat the GFC.…”

Do Lenders Still Discriminate? A Robust Approach for Assessing Differences in Menus

“…Pinpointing the precise mechanisms driving the mortgage pricing differences, we find, would be a promising path for future research. We discuss how unobserved credit risk is an unlikely explanation for our findings, because default risk is insured and minority borrowers have an especially favorable prepayment profile (Kau, Fang, andMunneke (2019), Gerardi, Willen, andZhang (2020)). We also rule out different levels of loan originator compensation as an explanation.…”

“…In particular, as shown in Ambrose, Conklin, and Lopez (2020), racial differences in default risk are very low among lower-LTV and higher-FICO borrowers, and in any case they are insured. Kau, Fang, and Munneke (2019) and Gerardi, Willen, and Zhang (2020) both show that the lower prepayment risk of minority borrowers makes the securities backed by their mortgages more valuable. Furthermore, it seems unlikely given the strict regulatory environment surrounding the mortgage market that lenders would condition their rate sheets and first offers based on race.…”

“…Second, for the types of mortgages we focus on, lenders are insured from the risk of default by either the GSEs or the FHA, which compensate investors for any losses of principal but do benefit from the more favorable prepayment risk of minorities. Therefore, in contrast to some stereotypes, mortgages from Black and Hispanic borrowers are likely significantly more valuable than those of observably similar white borrowers due to their lower prepayment risk, as shown in the simulations of Kau, Fang, and Munneke (2019) and in analyses of the actual mortgage-backed securities prices in Gerardi, Willen, and Zhang (2020). As a result, even if lenders did use unobservables that are correlated with race to price for expected loan performance in a possibly illegal manner, it would be unlikely to justify the unfavorable pricing to minorities we find.…”