Loan Product Steering in Mortgage Market

Abstract

Accusations of unscrupulous lender behavior — e.g., predatory lending — abounded during the housing boom of the 2000s. Such behavior is said to have generated significant social costs as borrowers were misled into accepting loans with inferior characteristics relative to the mortgage products that they should have qualified for. However, there is little hard evidence of such behavior and few estimates of the true effect of such behavior. Much of the research to date is based on anecdotal evidence or analyzes differential loan terms for broad groups of borrowers that are thought to have been targeted for such lending behavior. We employ a more direct methodology and test whether a particular form of this behavior existed during the housing boom: credit steering toward predatory-like loan terms. With this steering, the broker or real estate professional encourages the home buyer to access credit from a particular lender that provides the credit, but at unattractive terms. We find evidence of such behavior. That is, we find evidence consistent with lenders steering higher-quality borrowers to affiliates that provide subprime-like loans. These borrowers were charged 40-60 bps higher APR, and were 2% points less likely to default compared to similar borrowers who were not steered to such loans — consistent with the steered borrowers receiving inferior loans given their qualifications. Delving deeper, we find that the loans with steered borrowers were more likely to be privately securitized and steering was not concentrated solely among the large banks. Our results are, to our knowledge, the first explicit evidence of systematic mortgage lending abuse during the run-up in the housing markets.

Keywords: Mortgages, mortgage steering, subprime crisis, predatory lending, household finance

JEL Classification: D12, D18, G18, G21, K2