Volume 3 Number 7
July/August 2006

In this Issue
Outcomes of Permanent Housing Programs for the Homeless
Fair Housing: What the Public Knows and Supports
Exploring Subprime Mortgage Lending and Alternative Financial Services
Does Owning a Manufactured Home Make Sense?
In the next issue of ResearchWorks

Exploring Subprime Mortgage Lending and Alternative Financial Services

FULL TEXT: Download complete issue (*.pdf, 851 kB) Order a printed copy of the whole text

Subprime home mortgage lending has expanded markedly during the past two decades — particularly among minority and low-income households with atypical credit histories. The number of check cashers, payday lenders, pawnshops, and other alternative financial service providers (AFSPs) that make short-term loans to these households has also grown significantly. Affordable and fair housing advocates are concerned about the practices of AFSPs that unfairly target these vulnerable households by charging excessive fees and interest rates, which can result in higher rates of foreclosure on home loans and undermine the economic health and stability of communities. According to the Center for Responsible Living, “One of the most serious threats to people of color and low-wealth families in America is the prevalence of predatory financial practices, which drain $25 billion of their wealth each year.”

Subprime lending can result in higher rates of foreclosure on home loans and undermine a community’s economic stability.

HUD recently released an exploratory study of the extent to which neighborhood ethnic and racial characteristics, income levels, and credit-risk measures are related to the incidence of subprime mortgage lending, and to the physical location of AFSPs and banks. The study, Subprime Lending and Alternative Financial Service Providers: a Literature Review and Empirical Analysis, exhaustively reviews the research literature concerning subprime lending and its relationship to low-income and minority neighborhoods; AFSPs and the customers they serve, their location, and the business models they use; and regulatory and consumer protection policies. An overview of this body of research suggests that the underlying forces shaping present-day consumer financial services are not clearly understood. Much of the research, for example, has focused on supply-side issues, thus providing little insight into how and why low-income families choose between mainstream and alternative mortgage and financial services.

The report also contains an empirical case analysis of relationships among neighborhood characteristics, patterns of subprime lending, and the location of AFSPs and banks in the Dallas, Texas metropolitan area. Dallas lent itself well to this study because it has a good representation of blacks and Hispanics in its population, and Texas law allows payday lending. The Dallas study found that:

• Subprime lending occurs at higher rates in black neighborhoods, low-income neighborhoods, and higher credit-risk areas.

• Growth in subprime lending does not appear to be associated with a lack of banks in a given area.

• AFSPs and subprime lending did not appear to be significantly related in any way and may be serving different market niches.

Pawnshops are just one of many AFSPs found in some minority and low-income neighborhoods.

• AFSPs are commonly located in minority and low-income neighborhoods, but are disproportionately concentrated in Hispanic neighborhoods. This, however, may have more to do with a preponderance of immigrants in these neighborhoods, which is seen as the single best predictor of the presence of AFSPs.

• AFSP locations are not significantly associated with neighborhood credit risk, nor are they related to a lack of banks in an area.

• Race is more important than income for predicting the existence of banks in a neighborhood. Areas in which 90 percent of households are white have the most banks; Hispanic-majority areas have the fewest. Black- and white-majority neighborhoods have about the same representation of banks.

The Dallas study supports prior research that identified vulnerable borrowers. The current study finds that borrowers are less likely to use a subprime lender if they live in areas where home sales are active and residents have more education or possess greater financial literacy — findings that have policy implications favoring consumer education and market stimulation. In addition to exploring relationships among various parties in the consumer finance market, the Dallas study also tested measures of neighborhood credit risk and the suitability of available data for mapping AFSP locations. Being exploratory in nature, this study paves the way for further research and comparisons in other market areas.

The complete report on the Dallas study, including the literature review, is available online from HUD USER and can be downloaded for free at http://www.huduser.org/publications/hsgfin/sublending.html. Interested readers may want to examine two other reports available as free downloads: What We Know about Mortgage Lending Discrimination in America (http://www.huduser.org/publications/fairhsg/lending.html, also available in print for a nominal fee from HUD USER by calling 800.245.2691, option 1) and Curbing Predatory Home Lending: A Joint Report, sponsored by HUD and the U.S. Department of the Treasury in 2000 (http://www.huduser.org/publications/hsgfin/curbing.html).