Mortgage Prepayment, Race, and Monetary Policy

Black and Hispanic white borrowers pay more than 50 basis points higher interest rates than white borrowers in a large, representative sample of loans insured by Fannie Mae and Freddie Mac. The authors show this disparity is primarily driven by the fact that white borrowers are more likely to exploit periods of falling interest rates by refinancing their mortgages or moving.

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Key Findings

• A counterfactual experiment shows that even if all borrowers received the same rate at origination (that is, ignoring race and observable factors such as credit score and loan-to-value ratio), Black and Hispanic white borrowers would continue to pay much higher rates because they do not exploit periods of falling interest rates.
• Black and Hispanic white borrowers face significant obstacles to refinancing. Black and Hispanic white borrowers, on average, have lower credit scores, lower income, and higher leverage. Black borrowers are also more likely to be female and less likely to have a co-borrower. All of these factors lead to lower refinance propensities, regardless of race.
• Measurable obstacles to refinancing are only part of the story. Other social factors are at play. Even when a Black borrower and a non-Hispanic white borrower live in the same Zip code, have the same credit score and income, are of the same gender, and are observed in the same year and quarter, the Black borrower is still significantly less likely to refinance compared with the non-Hispanic white borrower.
• The Fed’s quantitative easing (QE) policy led to a large increase in racial rate inequality. On the day of the announcement of the first QE (November 25, 2008), the rate at which white borrowers refinanced increased by more than twice as much as the rate at which Black borrowers refinance. Over the next six months, the quarterly refinance probability for non-Hispanic white borrowers increased 3.2 percentage points (per quarter) compared with only 1 percentage point for Black borrowers. This led to a 21-basis-point drop in the rate for an outstanding mortgage for the average non-Hispanic white borrower versus a drop of only 9 basis points for the average Black borrower.

Implications

Policymakers can reduce mortgage rate inequality by helping minority borrowers to take greater advantage of the mortgage rate reductions. Enhanced streamlined refinance programs are one option. Another option is to create mortgages that embed an option to access lower rates without refinancing.

Abstract

Over the period 2005 to 2020, Black borrowers with mortgages insured by Fannie Mae or Freddie Mac paid interest rates that were almost 50 basis points higher than those paid by non-Hispanic white borrowers. We show that the main reason is that non-Hispanic white borrowers are much more likely to exploit periods of falling interest rates by refinancing their mortgages or moving. Black and Hispanic white borrowers face challenges refinancing because, on average, they have lower credit scores, equity, and income. But even holding those factors constant, Black and Hispanic white borrowers refinance less, suggesting that other social factors are at play. Because they are more likely to exploit lower interest rates, white borrowers benefit more from monetary expansions. Policies that reduce barriers to refinancing for minority borrowers and alternative mortgage contract designs that more directly pass through interest rate declines to borrowers can reduce racial mortgage pricing inequality.

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