Bad Credit and Intergroup Differences in Loan Denial Rates

Economic Research International, Forthcoming

Posted: 13 Mar 2012

See all articles by Sheila Ards

Sheila Ards

University of Minnesota

Inhyuck Ha

Western Carolina University

Jose L. Mazas

affiliation not provided to SSRN

Samuel Myers

University of Minnesota - Twin Cities - Hubert H. Humphrey Institute of Public Affairs

Date Written: 2012

Abstract

Research has found wide disparities in loan denial rates among different racial/ ethnic groups. Two competing explanations for these gaps arise. One argument is that these disparities result from underlying racial disparities in credit worthiness. A competing view is that the disparities arise from a pattern of racial discrimination among mortgage lenders. This paper adopts a stratification economics approach to evaluate these competing claims. Using Freddie Mac’s Consumer Credit Survey dataset, we test the hypothesis that measures of discrimination disappear when one accounts for racial differences in credit scores. A novel contribution of the paper, built upon the premise that inter-group inequalities sustain themselves through self-fulfilling mechanisms, is to test the hypothesis that loan denials explain misperceptions of credit worthiness. We demonstrate that one cause of the appearance of poor credit risk among black applicants is that blacks with good credit risk underestimate their credit worthiness and apply for loans in lower numbers. Our findings suggest that even nondiscriminatory lending behavior has the unintended effect of screening out low-risk blacks and thereby yields higher denial rates among blacks. This in turn confirms prior beliefs about the poor credit of average black applicants. Much, but not all, of the racial disparity in loan outcomes can be explained by racial differences in credit scores and the resulting racial disparity in loan outcomes explains much of the racial difference in false perceptions about bad credit. Thus, a possible self-fulfilling mechanism remains within the credit market that perpetuates views about black bad credit.

Keywords: credit, loans, race, disparity, Freddie Mac, black

Suggested Citation

Ards, Sheila and Ha, Inhyuck and Mazas, Jose L. and Myers, Samuel, Bad Credit and Intergroup Differences in Loan Denial Rates (2012). Economic Research International, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2020460

Sheila Ards

University of Minnesota ( email )

308 Harvard Street SE
United States

Inhyuck Ha

Western Carolina University ( email )

Cullowhee, NC 28723
United States

Jose L. Mazas

affiliation not provided to SSRN ( email )

Samuel Myers (Contact Author)

University of Minnesota - Twin Cities - Hubert H. Humphrey Institute of Public Affairs ( email )

301 19th Ave S
Minneapolis, MN 55455
United States

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