Why It Costs More to Borrow if You're Black

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Yes. There's a wealth gap in America. We've talked about it here. It's large, alarming, and problematic. Consider these numbers: The median net worth of black and Latino families in 2014 was $9,590 and $17,530, respectively. The median net worth of a white family was $130,800.

Or this: Researchers at Yale and Northwestern estimated that for every $100 in white family wealth, black families hold $5.04.

And the only thing more surprising than how big the gap is? How unaware of it most of us are. When participants in that Yale and Northwestern study were asked what they thought the gap would be, they guessed that black families had $80 for every $100 — off by about 1,500%.

If we want to narrow that gap, we have to ask ourselves why it exists in the first place. It begins, of course, with our history: slavery, Jim Crow, practices like redlining (which we'll learn more about below), structural discrimination that kept some people from having the same opportunities as others — or any opportunity at all. And, of course, it's partly the effect of people of color being paid less for the same work — the so-called wage gap. It's also partly because wealth is self-perpetuating — the renowned French economist Thomas Piketty recently cowrote a paper that estimated that 60% of America’s wealth is inherited. Think about that: Of the net worth of all the people in all the houses and apartments and shacks and condos and tents and camper vans in all of America, more than half of it was simply given to them.

But there is a financial reason for the wealth gap that's more invisible but also incredibly powerful: the cost of borrowing. As anyone who knows how compounding works can tell you, even a small difference in interest rates can become huge and consequential over time.

And the differences that exist aren't small.

The first thing to understand is just how fundamental borrowing money is to the way our economy works. Borrowing is how people can afford to go to school, start businesses, buy houses — all of which are instrumental in building wealth, which wealth will change the fate of future generations. If it's done right, borrowing (or, as it's known in the biz of business, debt) is an incredible tool. But when it goes wrong... well, it's also a unique financial wrecking ball.

Here are the ways it's different (and worse) to borrow money if you're a person of color:

It Costs More to Get a Mortgage for the Same House if You're Black or Hispanic

Interest rates are consequential. The importance of minimizing the money you're paying to financial institutions is a founding principle at Wealthsimple (alongside the one that says: financial freedom should be more of a right than a privilege). That's why the findings in a study by the Center for Investigative Reporting about mortgage lending are so important. Their analysis of 31 million mortgage application records found that African Americans and Latinos were much more likely to be denied conventional mortgage loans than white Americans were, even after controlling for factors like an applicant’s income, the amount of the loan, debt-to-income ratio, type of lender, and even the neighborhood where the property is.

That means that African Americans and Latinos were much more likely to be rejected by private lenders (banks, credit unions, mortgage companies) as well as government-sponsored enterprises (Fannie Mae and Freddie Mac).

Another study from researchers at UC Berkeley found that both human loan officers and algorithms designed by financial firms tended to offer Latino and African American borrowers higher interest rates on government-backed mortgages than similarly qualified white applicants — on an average of six to nine basis points (or .06–.09%) higher for conventional mortgages.

The U.S. Census Bureau estimated black homeownership to be 41.7% in the third quarter of 2018, about the same rate as it was in 1970.

Black and Hispanic families are also a whole lot more likely to have more dangerous, predatory loans. Those are often the only loans available when you lack wealth to begin with. When the financial crisis of 2007 hit, more than half of all black homebuyers and 41% of Hispanic buyers lived in homes financed by subprime mortgages — compared to just 22% of whites. That's part of the reason that, in the decade since the crash, the Federal Reserve Bank of St. Louis found that 28.6% of mortgage loans held by black borrowers, and 31.7% held by Hispanic borrowers went into foreclosure. And ironically, the crisis hit higher-earning college-educated minority households the hardest: the people who had managed to build enough wealth to invest in a home. And that amounted to a catastrophic loss of equity and wealth.

It's part of the reason, for instance, that the U.S. Census Bureau estimated black homeownership to be 41.7% in the third quarter of 2018, about the same rate as it was in 1970.

Blacks and Latinos Are More Likely to Buy Their Homes With a High-Cost Loan

A high-cost loan is defined as one with an interest rate that's at least 3% higher than comparable treasury securities, currently about 7%. One study by the National Bureau of Economic Research found that African Americans are 105% more likely, and Latinos are 78% more likely, than white Americans to have a high-cost home loan.

If you want to understand the difference between a good mortgage rate and a bad one check out the graph we made above. It assumes you bought a home at the median price ($325,000) tomorrow, put down 20% and borrowed 80% on a 30 year fixed-rate mortgage. A sub-prime mortgage would mean you paid the bank almost $150,000 extra by the time you were done.

It also costs more to buy a car if you're black or Hispanic.

An investigation by the National Fair Housing Alliance Black found that Latinos, Asians, or Native Americans who shopped for cars were not offered the same rebates as their white counterparts, and they were offered loans with higher interest rates. As a result, these groups would have paid an average of $2,662.56 more over the life of the loan than their less-qualified white cohort.

People of color are more likely to have student debt.

According to the U.S. Census Bureau, African American and Hispanic Americans are more likely to have student debt than whites (23.6% and 20.3%, compared to 18.3% for white Americans).

And a study published in the journal for Sociology of Race and Ethnicity found that black students reported 85% more education-related debt than their white peers. It's another way the lack of wealth can be self-perpetuating — those whose families can't pay for their schooling are more likely to end up locked in a situation that makes it less likely that they themselves will be able to build wealth.

There's also a higher incidence of credit card debt.

Paying higher interest rates means you essentially have less money. It increases the burden of debt repayment and leaves less for daily needs and emergencies. And it makes it more likely for a person to end up with credit card debt.

According to the 2016 Survey of Consumer Finances, more African American and Latino families have credit card debt than white American families. And what's more, according to a ProPublica investigation, when African American and Latinos default on that credit card debt, they are more likely to be sued for defaulting on payments than white Americans. Which can mean wages are garnished, which can mean less money for mortgages or necessities, and more trouble if an emergency strikes — like being laid off or getting hit with unexpected medical bills. And defaulting also means taking a hit on your credit score, which makes it impossible to get good terms on your next loan, which increases borrowing cost, which increases likelihood of default. You get it — it's a vicious circle.

And a greater chance of using payday loans — by far the worst way to borrow.

A payday loan is a small amount of money, usually under $500, lent at a very high interest rate under the premise it will be repaid when the borrower receives his next paycheck. The Pew Charitable Trusts estimated that 12 million Americans use payday loans. They are perhaps the worst, most damaging kind of loan. They have astronomical interest rates — as high as 667% per year — and lots of other high fees, and can quickly spiral into huge sums. ProPublica reported on a woman in St. Louis whose $1,000 loan skyrocketed to $40,000 in five years after she made a few payments and then defaulted.

Another report from the Pew Charitable Trusts found that African Americans were more than twice as likely to have used a payday loan compared with other borrowers.

The borrowing gap has its roots in historic, systemic discrimination.

One of the foundational reasons for the entire phenomenon of the wealth gap goes back to some simple acts of discrimination. For instance: Do you know about the GI Bill that was passed at the end of World War II? One of the benefits of the bill, which went into effect in 1944, was that veterans were eligible for low-interest home loans with no down payment. It was one of the financial underpinnings of the huge postwar expansion of the middle class. The loans were guaranteed by the Department of Veteran Affairs, but a report from the Equal Justice Initiative notes that very few black veterans received those loans. And that was because “they required cooperation from local banks.” Those local financial institutions were often unwilling to extend credit to black veterans.

The truth is, the government has had an enormous role in keeping the costs of a lot of mortgages down (and in helping people build wealth more generally — the whole notion of the 401(k) and the IRA is predicated on the government willingly forgoing its own balance sheet to entice people to bolster their own). And the government's largess has not always been distributed equitably. For instance, the Federal Housing Administration insures lots of mortgages, and their approval usually means a lower interest rate for the borrower, not to mention that a smaller down payment will be required (which makes it easier to buy a first home). But in the 1930s, the FHA adopted a grading system of maps that rated neighborhoods according to their perceived stability and their racial demographics. Neighborhoods where black people lived were rated the lowest grade of “D” and were usually considered not eligible for FHA insurance — it was part of the process of denying loans and insurance known as "redlining.” This practice not only resulted in low approval rates for minorities, but contributed mightily to plummeting home values in minority neighborhoods. The writer Ta-Nehisi Coates wrote about this policy in his blockbuster piece in The Atlantic about the economic disenfranchisement of black Americans after slavery. “Redlining went beyond FHA-backed loans and spread to the entire mortgage industry,” he wrote, “which was already rife with racism, excluding black people from most legitimate means of obtaining a mortgage.”

Black families who were denied FHA-backed mortgages were then sold predatory contract sales agreements — expensive contracts for inflated home prices, with punishing terms. And this made it virtually impossible for black people to build equity in their homes, the way white America was doing.

Redlining was an open practice for 33 years — until the Fair Housing Act passed in 1968. But like a lot of the structural reasons that reinforce financial equality, evidence of it still lingers today.

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