Is Discretionary Pricing Discretionary? The Case of Overages in Mortgage Lending

Abstract:     
Research on moral hazard and adverse selection indicates that restricting the ability of lenders to price loans could result in less credit being extended to those in the riskiest credit tier. This has several implications for mortgage lending and overages in particular. First, given that blacks tend to have worse credit than similarly situated whites, then they would be worse off if overages were banned. Second, borrowers who are unfamiliar with the financial system, such as first-time customers, probably require more effort on the part of the loan officer. Guiding such applicants through the loan process necessarily takes more time. Unless lenders can recover the cost of this time and effort, the number and volume of loans to such borrowers will probably decrease. Third, research indicates that blacks do not bargain or comparison shop as much as whites. This implies that, ceteris paribus, markup differences can persist even after accounting for risk, service and demographic variables. Finally, these differences may vary across local markets throughout the country. Future research efforts should study loan payment performance after controlling for market forces within the relevant local market. If unexplained pricing differentials exist between minorities and whites, yet loan payments performance is the same, then the differential could contain an arbitrary pricing component that is discriminatory. Alternatively, if unexplained differentials correspond to payment performance, then these differentials are not arbitrary and discriminatory but market driven. Thus, policy makers and regulators should not strive to eliminate differential pricing but should concern themselves with those differences that are unrelated to market forces.

Accepted Paper Series