HUD Proposes Administrative Modifications to the Real Estate Settlement Procedures Act

HUD Proposes Administrative Modifications to the
Real Estate Settlement Procedures Act
April 10, 2008
Darryl E. Getter
Specialist in Financial Economics
Government and Finance Division

HUD Proposes Administrative Modifications to the Real
Estate Settlement Procedures Act
Summary
Recent unsettling developments in the subprime home loan market have
triggered concern in Congress and among the public as to whether borrowers were
fully informed about the terms of their mortgage loans. Some observers have
suggested that numerous borrowers in the subprime market may have been victims
of predatory lending practices or other discriminatory activity. Several bills have
been introduced in the 110^th Congress that would seek to remedy these perceived
abuses. Senate bills S. 1222 (Senator Barack Obama et al.), S. 1299 (Senator Charles
Schumer et al.), S. 1386 (Senator Jack Reed et al.), and House bill H.R. 2061
(Representative Stephanie Tubbs Jones et al.) include both suitability and disclosure
approaches for addressing these concerns.
This report focuses on borrower disclosure, in particular with respect to making
all pertinent information about loan terms and settlement costs transparent, so
consumers can make well-informed financial decisions when choosing mortgage
products. The Real Estate Settlement Procedures Act (RESPA) of 1974 requires
standardized disclosures about the settlement or closing costs of residential
mortgages. The Department of Housing and Urban Development (HUD) has
proposed changes to RESPA designed to facilitate better understanding of mortgage
terms as well as to enhance the ability of borrowers to shop for better terms. These
changes include (1) a new, standardized good faith estimate (GFE) form; (2) changes
in how the yield spread premium (YSP) or broker compensation would be disclosed
to the borrower; (3) modifications to the HUD-1 settlement statement; (4) a reading
of the mortgage terms to the borrower at the closing table; and (5) allowing for
discount pricing of settlement services that would potentially benefit borrowers.
HUD plans also to seek legislative changes to enhance its enforcement authority of
RESPA.
After reviewing specific regulatory reforms, this report provides some survey
evidence on the extent of consumer shopping behavior prior to entering into such
expensive financial transactions. While there has been concern about lenders not
doing enough to provide affordable mortgages, it is also arguably in the best interest
of borrowers to shop diligently for the best credit terms. Even if borrowers are made
aware of the costs, they may still elect to obtain less affordable mortgages over the
entire loan term. Hence, disclosure reform as a way to influence affordability still
depends upon the judgement of consumers.

Contents
In troduction ......................................................1
HUD-Proposed RESPA Modifications.................................2
The Good Faith Estimate (GFE) Form ............................2
Disclosure of Mortgage Broker Compensation ......................4
Disclosures Occurring at the Closing Table.........................5
Revisions to HUD-1 Settlement Statement......................5
Closing Script............................................5
Average Cost Pricing and Volume Discounts........................6
Proposed Legislative Actions.....................................6
Examination of Mortgage Loan Price Differentials and Shopping Behavior
Among Consumers.............................................6
List of Tables
Table 1. Percentages of Homeowners Who Aggressively Shop for Best
Credit Terms.................................................7
Table 2. Do Interest Rate Differentials Provide Incentive to Shop?...........8
Table 3. Rates Paid by High Credit Quality Borrowers on Fixed-Rate
Mortgages....................................................9

HUD Proposes Administrative Modifications
to the Real Estate Settlement Procedures
Act
Introduction
Uncertainty generated by recent subprime mortgage repayment problems and
subsequent foreclosures has generated concern in Congress and among the public as
to whether borrowers are taking on loans they can not afford.¹ Borrowers may have
obtained expensive, unaffordable loans for various reasons. Perhaps the actual costs
of the mortgage were hidden or simply not transparent when borrowers entered into
these transactions. Hidden costs can act as a payment shock to a borrower, causing
financial distress which could possibly lead to rising foreclosure rates. Borrowers
may have entered into high cost loans as a result of discrimination. Recent mortgage
repayment problems may reflect a rise in various forms of predatory lending.
This report focuses on current disclosure legislation, which requires the
reporting of pertinent loan information to consumers. The Real Estate Settlement
Procedures Act (RESPA) of 1974 requires standardized disclosures about the
settlement or closing costs, which are costs associated with the acquisition of
residential mortgages.² Examples of such costs include loan origination fees or
points, credit report fees, property appraisal fees, mortgage insurance fees, title
insurance fees, home and flood insurance fees, recording fees, attorney fees, and
escrow account deposits. RESPA currently includes the following provisions: (1)
providers of settlement services are required to provide a good faith estimate (GFE)
of the settlement service costs borrowers should expect at the closing of their
mortgage loans; (2) a list of the actual closing costs must be provided to borrowers
at the time of closing, which are typically listed on the HUD-1 settlement statement;
and (3) RESPA prohibits “referral fees” or “kickbacks” among settlement service
providers to prevent settlement fees from increasing unnecessarily. The Department
of Housing and Urban Development (HUD) currently implements RESPA.
The Truth-In-Lending Act (TILA) of 1968 is another element of the consumer
disclosure regime.³ TILA requires lenders to disclose the cost of credit and
repayment terms of mortgage loans before borrowers enter into any transactions. The

¹ For more detailed information on subprime lending, see CRS Report RL33930, Subprime
Mortgages: Primer on Current Lending and Foreclosure Issues, by Edward Vincent
Murphy.
² P.L. 93-533, 88 Stat. 1724, 12 U.S.C. Sections 2601-2617.
³ TILA is contained in Title I of the Consumer Credit Protection Act, P.L. 90-301, 81 Stat.

146, as amended by 15 U.S.C. Section 1601 et seq.

Federal Reserve Board implements TILA through Regulation Z. When homes are
purchased, both a real estate and a financial transaction take place simultaneously.
TILA governs the disclosure of the credit costs and terms, and RESPA governs
disclosure of the closing costs. RESPA may be a reasonable place to implement
disclosure improvements specific to the homebuying process, but such reforms
arguably could occur under TILA, since they pertain to GFE disclosures that cover
lending costs and terms.⁴
HUD has again proposed changes to RESPA designed to enhance the ability of
homebuyers to understand mortgage terms and associated costs as well as enhance
their ability to shop for the best deals.⁵ More transparent information could enhance
consumer shopping and discourage predatory, discriminatory, and fraudulent lending
practices. Various legislative disclosure proposals, however, arguably depend upon
consumers to make prudent choices. Consumers may be fully aware that a particular
mortgage loan and associated costs may be expensive yet decide to assume the loan.
Disclosure reforms, therefore, may not ensure that consumers will choose more
affordable mortgage loans. Evidence on the shopping behavior of consumers will
also be presented, which may provide some indication of the extent to which
consumers shop to obtain the best terms.
HUD-Proposed RESPA Modifications
The sections below highlight what may be considered the major items in the
recent proposed RESPA revisions, published in March 2008. HUD proposes (1) a
new, standardized GFE form; (2) changes in how the yield spread premium (YSP)
or broker compensation would be disclosed to the borrower; (3) modifications to the
HUD-1 settlement statement; (4) a reading of the mortgage terms to the borrower at
the closing table; and (5) allowing for discount pricing of settlement services that
would potentially benefit borrowers. HUD plans also to seek legislative changes that
are discussed below.
The Good Faith Estimate (GFE) Form
Although current GFEs contain disclosures that are required by TILA and
RESPA, evidence suggests that borrowers still have difficulty understanding and
locating relevant mortgage information. A Federal Trade Commission (FTC) study
tested 819 consumers to document their understanding of current mortgage cost
disclosures and loan terms, as well as their ability to avoid deceptive lending

⁴ See Patricia A. McCoy, “Rethinking Disclosure in a World of Risk-Based Pricing,”
Harvard Journal on Legislation, vol. 44, 2007.
⁵ See HUD’s RESPA home page at [http://www.hud.gov/offices/hsg/sfh/res/respa_hm.cfm],
which links to the proposed ruling that appeared in the Federal Register, vol. 73, no. 51,
March 14, 2008. HUD proposed RESPA revisions on July 29, 2002, but withdrew its
recommendations on March 22, 2004 for further consideration and analysis. See letter from
Office of Management and Budget addressed to Acting HUD Secretary dated March 22,

2004, at [http://www.reginfo.gov/public/postreview/hud_response9.pdf].

practices.⁶ The authors found both prime and subprime borrowers did not understand
important mortgage costs after viewing mortgage cost disclosures. Some borrowers
had difficulty identifying the annual percentage rate (APR) of the loan and loan
amounts. Many borrowers did not understand why the interest rate and APR of a
loan would differ.⁷ In addition, borrowers had the most trouble understanding loan
terms for the more complicated mortgage products such as those with optional credit
insurance, interest-only payments, balloon payments, and prepayment penalties.
More borrowers were unable to determine whether balloon payments, prepayment
penalties or up-front loan charges were part of the loan.
HUD has proposed a new, standardized GFE with recommended changes that
it argues will help consumers better understand and locate relevant information about
their mortgage products.⁸ For example, the proposed GFE conveys information about
the mortgage terms, whether the interest rate can rise, whether the overall loan
balance can rise, whether the loan has a prepayment penalty, whether the loan has a
balloon payment, and whether the quoted monthly payment includes a monthly
escrow payment for taxes. All of this information about the loan appears on the first
page of the GFE. The first page also includes a lump-sum total amount of all
estimated settlement fees. Furthermore, a separate GFE will be required for each
loan product. For example, a borrower may wish to compare a traditional fixed rate
mortgage (FRM) loan with an adjustable rate mortgage (ARM) loan. Both mortgage
products must have separate GFEs to ensure that the information provided is unique
to each product. HUD argues that these changes to the GFE will lead to less
confusion about loan and settlement costs, help the borrower better determine
product affordability, and improve comparison shopping.⁹
In addition to providing a shopping tool for consumers, the HUD proposal also
seeks to provide reliable GFEs in the sense that estimated costs do not change
substantially by the time consumers are ready to close on their loans. Shopping for
the best deal or an affordable loan would be meaningless if the costs were to change
when borrowers arrived at closing. Consequently, page 3 of the proposed GFE lists
charges that can not increase, charges that are allowed to increase up to 10%, and
charges that may change at settlement. For specific charges that should not change
or exceed the 10% limit, borrowers would have the option to withdraw their
applications and receive full refund of all loan related fees. This change would make
it difficult for lenders to generate “costs” or fees that could not be easily justified.

⁶ See James M. Lacko and Janis K. Pappalardo, Improving Consumer Mortgage
Disclosures: An Empirical Assessment of Current and Prototype Disclosure Forms, Bureau
of Economics Staff Report, Federal Trade Commission, June 2007,
[ h t t p : / / www.f t c.go v/ os/ 2007/ 06/ P025505Mor t gageDi s cl osur eRepor t .pdf ] .
⁷ The APR is the annual cost of a loan, which includes the interest cost of the principal loan
amount, insurance, and other fees expressed as a percentage. The mortgage interest rate
only includes the interest cost of the principal loan amount expressed as a percentage.
⁸ See the proposed GFE at [http://www.hud.gov/offices/hsg/sfh/res/200803/5180GFE.pdf].
⁹ HUD has tested this proposed GFE form among various consumer groups; details about
these tests may be found at [http://www.hud.gov/offices/hsg/sfh/res/200803/summary.pdf].

These GFE disclosure requirements may generate controversy. After an earlier
proposed ruling concerning GFE modifications and requirements, loan originators
argued the GFE would essentially become a binding or final quote, which would be
extremely difficult to provide without underwriting. One reason for this criticism
stemmed from the fact that loan pricing depends upon having information about
borrower credit history and ability to pay. Loan originators need to assess borrower
risk (and perhaps the riskiness of the collateral) to generate a binding quote, in
particular for high-risk borrowers, a process which takes time and money.
The HUD proposal defines two stages in the overall mortgage seeking process,
which could be interpreted as a response to the earlier criticism.¹⁰ The consumer
receives a GFE in stage 1, which occurs prior to the proceeding with the official
mortgage application in stage 2. In the first stage, the lender is not expected to have
performed any underwriting, and the GFE need only consist of information obtained
from the borrower without any verification of borrower statements. Final
underwriting is expected to begin in stage 2 after the borrower has expressed a
willingness to proceed with an official mortgage application. The GFE becomes
binding only if the underwriting process confirms borrower statements and loan
qualifications. If the underwriting process reveals that the borrower is unable to
qualify for the specific loan product, then the lender may reject the borrower or
propose a new GFE for another loan product in which the borrower is more likely to
qualify.
If the proposed two-stage process is implemented, then the final loan rates
initially stated on the GFE forms would likely become the actual ones borrowers
would receive after underwriting, since the majority of borrowers are considered
prime or high credit-quality. Lenders currently advertise the interest rates that prime
borrowers are likely to be charged, and high credit quality borrowers are arguably
already able to shop for loans.¹¹ Subprime or high risk borrowers, however,
encounter difficulties shopping for loan rates and may continue to do so under this
proposed system. Lenders typically charge higher rates to riskier borrowers to
compensate for the additional risk, and such rates are typically determined after
underwriting has occurred. Hence, low credit quality borrowers may be less likely
to obtain estimates of loan rates prior to final underwriting that would not change
afterwards. Assuming no substantial shifts in the current proportion of prime relative
to subprime borrowers, or that the share of prime borrowers diminishes as a result of
further borrower risk gradations, underwriting at the GFE stage might not be
necessary for the vast majority of consumers to obtain fairly reliable pricing
information of mortgage products.
Disclosure of Mortgage Broker Compensation
HUD is proposing a new way to disclose to the borrower how the lending
institution or a mortgage broker, who is an agent that works for a lending institution,
is paid. Loan charges may be collected either through points (upfront fees), or via the

¹⁰ See Federal Register, vol. 73, no. 51, March 14, 2008, p. 14035.
¹¹ See Patricia A. McCoy, “Rethinking Disclosure in a World of Risk-Based Pricing,”
Harvard Journal on Legislation, vol. 44, no. 1, winter 2007.

interest rate mechanism, which is referred to as the yield spread premium (YSP), or
some combination of these two pricing mechanisms.¹² On page two of the proposed
GSE form, the total origination costs are disclosed in item 1. The division of these
costs into points and YSP is disclosed in item 2. A “credit” that represents the dollar
value of loan origination costs not paid at settlement would appear in item 2. In this
context, “credit” does not mean the borrower would receive a refund from the loan
originator. Instead, credit refers to the loan origination costs that the borrower still
pays, not upfront at settlement, but in the form of a higher interest rate, or the YSP.
Conversely, the dollar value of fees paid upfront at settlement would appear as a
“charge” in item 2. For a given interest rate, both credit and charge amounts in item
2 should add up to the total loan origination costs, which appears in item 1. The
adjusted origination costs, which appear in box A, are the difference between the
total loan origination costs and the YSP; the adjusted origination costs refers to the
amount of total upfront fees that will be paid at settlement.
If borrowers realize that mortgage loan origination costs may be collected by
some combination of upfront fees and YSP, then they may also realize that it is
possible to choose between paying higher upfront fees for a lower interest rate or
lower upfront fees for a higher interest rate. In order to facilitate the understanding
of the tradeoff between interest rates and points, HUD has also proposed including
a comparison table on page three of the new GFE form. For any given loan
arrangement, the proposed GFE discloses how a loan with the same principal face
value and a lower interest rate results in higher upfront settlement costs; it discloses
how the same loan with a higher interest rate results in lower upfront settlement
costs.¹³
Disclosures Occurring at the Closing Table
Revisions to HUD-1 Settlement Statement. As stated earlier, the use of
a standardized HUD-1 settlement statement is required at all settlements or closings
involving mortgage loans. The HUD-1 lists all settlement charges paid at closing,
the seller’s net proceeds, and the buyer’s net payment. HUD proposes modifying the
HUD-1 to link GFE and HUD-1 charges. The itemized charges listed on the HUD-1
would include references to the same charges originally listed on the proposed GFE.
With these references, it may become more apparent to borrowers what charges
remained the same or changed from the estimation stage to the closing stage.
Closing Script. HUD has proposed a closing script that settlement agents
must read to borrowers at closing. The closing script, which, like the GFE, is
prepared for each loan type, restates the loan terms and highlights any changes in

¹² The mortgage interest rate and the YSP are not identical. The YSP is defined as the
difference between the total coupon interest rate and the actual wholesale interest rate of the
loan. For example, a loan with a market or wholesale rate of 6% may have a total coupon
rate of 6.5%, and 0.5% is the compensation going to the mortgage broker, which is the YSP.
Some mortgage lenders may pay brokers up to 2% in YSP.
¹³ The GFE never discusses loan details using the term annual percentage rate (APR), which
expresses the total interest and settlement costs as a percentage.

charges or fees that occurred from preparation of the initial GFE to settlement. The
borrower must sign and be given a copy of the closing script after it has been read.
Average Cost Pricing and Volume Discounts
In another element of the RESPA revisions package, HUD proposes permitting
average cost pricing and volume discounts on settlement service fees. While still
making it unlawful for lenders or settlement agents to benefit from kickbacks that
increase borrower fees, the proposal would allow pricing arrangements that may
financially benefit borrowers. Average cost pricing refers to dividing the total costs
associated with a specific service (e.g. appraisal service) by the total number of
services (appraisals) provided, and charging borrowers for the average cost of the
services. Average cost pricing may apply to all services. Under this system, some
borrowers will pay less for services that may actually cost more; but the proposed
rule prevents some borrowers with actual fees below the average cost to be charged
more than average cost. The average cost of various service fees, which will be
computed over specified periods, will be based upon methods established by HUD.
Settlement service agents will also be permitted to provide volume discounts that
may be passed on to borrowers.
Proposed Legislative Actions
HUD also seeks legislative changes that will give the agency greater statutory
authority to enforce specific sections of RESPA, in particular sections dealing with
key disclosure provisions.¹⁴ The Department of HUD requests that the HUD
Secretary be granted the authority to impose penalties for RESPA violations.
Legislation may also be necessary to authorize procedures requiring that borrowers
receive the HUD-1 closing statement three days before settlement and establishing
a uniform statute of limitations for RESPA violations.
Examination of Mortgage Loan Price Differentials
and Shopping Behavior Among Consumers
Assuming implementation issues such as costs associated with reforming
RESPA are addressed, consumers still need to shop actively for the best loan terms¹⁵
to obtain more affordable mortgage products. In this section, the Federal Reserve
Board’s 2004 Survey of Consumer Finances (SCF) is used to examine consumer¹⁶
behavior with regards to shopping for affordable credit terms. Assuming

¹⁴ See Federal Register, vol. 73, no. 51, March 14, 2008, p. 14033.
¹⁵ In a press release, the Mortgage Bankers Association alludes to the amount paperwork,
which translates into costs, that would increase if the RESPA proposal were implemented
at [http://www.mortgagebankers.org/NewsandMedia/PressCenter/60847.htm].
¹⁶ The SCF, which is compiled every three years by the Federal Reserve Board, provides
information on the assets, liabilities, and demographic characteristics of approximately 4000
U.S. families. For more information about the 2004 SCF, see Brian K. Bucks, Arthur B.
(continued...)

competitive market behavior, borrowers having similar risk characteristics should
pay similar rates for their loans. Evidence pertaining to mortgage pricing
differentials and shopping behavior will be presented.¹⁷
All SCF respondents were asked if they were more likely to “shop around for
the best credit terms.” Mortgages originating between 1996 through 2004 were
retained for this analysis. The responses to the survey question make it possible to
identify whether homeowners exhibited behavior consistent with obtaining an
affordable mortgage loan rate. The results in Table 1 suggest that less than a third
of the homeowners in the sample admit to shopping aggressively for the best credit
terms. There is little behavioral difference between borrowers with fixed rate or
adjustable rate mortgages (ARMs). Homeowners obtaining ARMs may not
aggressively shop if they had planned either not to stay in their residences for a long
period of time or to refinance in the near future. Fixed rate borrowers, however,
would be expected to have significantly higher shopping rates than borrowers with
ARMs, since they would be locking in a rate for a longer period of time. The results
indicate that relatively few borrowers shop aggressively to acquire the best credit
terms.
Table 1. Percentages of Homeowners Who Aggressively Shop
for Best Credit Terms
Total NumberTotal WhoTotal w/ Fixed RateTotal w/ ARMs
Homeowners inShopMortgages Who ShopWho Shop
Sam pl e Aggressively Aggressively

1809 26.5% 26.9% 23.9%

^Source:^C^R^S^cal^cu^l^a^tⁱ^oⁿ^s^u^sⁱⁿ^g^t^h^{e 2004 S}^C^F^,^F^e^deral^R^e^s^e^rv^{e Board.}
Were the differences in rates large enough for shopping to matter? Answering
this question requires placing some controls on the data sample and variables. The¹⁸
data set has been limited to include only fixed-rate conforming mortgages.
Mortgage holders with traditional 30-year fixed-rate conforming mortgages were
chosen for this part of the analysis to avoid mixing of terms, adjustable, or jumbo
mortgage loan rates. Unlike adjustable rate mortgages (ARMs), borrowers with fixed
rate mortgages do not share interest rate risk with the lender. When interest rates

¹⁶ (...continued)
Kennickell, and Kevin B. Moore, “Recent Changes in U.S. Family Finances: Evidence from
the 2001 and 2004 Survey of Consumer Finances,” Federal Reserve Bulletin, vol. 92
February 2006, pp. A1-A38.
¹⁷ All descriptive statistics presented in this analysis are computed using SCF sample
weights. For information about the weights, see Arthur B. Kennickell, Revisions of the SCF
Weighting Methodology: Accounting for Race/Ethnicity and Homeownership (Washington:
Board of Governors of the Federal Reserve System, December 1990,
[ ht t p: / / www.f e der a l r eser ve .gov/ pubs/ oss/ oss2/ met hod.ht ml ] .
¹⁸ The definition of a conforming loan is a mortgage loan that meets the guidelines set by
Fannie Mae and Freddie Mac.

change, borrower cash outlays remain unchanged if they have traditional fixed rate
mortgages. Hence, the risk-preference characteristics of the borrower are held
constant in this analysis.
It is possible to control for some of the interest rate volatility over the time,
since the SCF asks respondents for the year they obtained their mortgage.¹⁹ The
mortgage loan rates were normalized by the average rate for the year in which they
were obtained, so borrowers with mortgages in different years could be compared.
For example, a borrower might report obtaining a 30-year fixed loan in 2002 with an
interest rate of 6%. Given that the average conventional 30-year fixed mortgage rate
in 2002 was 6.54%, according to interest rate data provided by Freddie Mac, the
normalized loan rate is 6/6.54, or a value of 0.9174. This indicates the borrower
received a loan price below average during that year. All loan rates reported by 2004
survey respondents have been normalized by the average mortgage rate by origination
year; then a loan price distribution was produced to compare rate pricing
differentials.²⁰
Table 2 shows the mean normalized rates for the bottom and top portions of the
mortgage interest rate distribution for all homeowners in the sample. Homeowners
in the bottom 25% of the loan distribution paid lower interest rates for their loans
relative to homeowners in the top 25% of the distribution. The average rate in the
bottom quartile was 47% lower than the mean rate in the top quartile, and the mean
mortgage rates in the top and bottom quartiles were statistically different from each
other at the 99% level of significance.²¹ These results indicate that an incentive to
shop for the best credit terms would have existed, given the wide range of available
interest rates.
Table 2. Do Interest Rate Differentials Provide
Incentive to Shop?
Actual NumberMeanStandard
Borrowers inNormalizedDeviation of
QuartileMortgage RatesNormalized Rates
Bottom Quartile1730.79780.0031
Top Quartile1461.17310.0056
^Source:^C^R^S^cal^cu^l^a^tⁱ^oⁿ^s^u^sⁱⁿ^g^t^h^{e 2004 S}^C^F^,^F^e^deral^R^e^s^e^rv^{e Board.}
Did creditworthy borrowers get better pricing relative to those of low credit
quality? Assuming lenders price according to borrower risk, a larger share of high
credit quality borrowers would be expected to pay rates in the bottom quartile. Does

¹⁹ The SCF does not have information on closing costs, so it is not possible to use APRs.
²⁰ There was very little month-to-month volatility in 1996 through 2002, but volatility
increased from 2002 through 2004 as interest rates declined.
²¹ The median interest rates were 0.8162 for the bottom quartile and 1.1168 for the top
quartile.

aggressive shopping help high credit quality borrowers receive more favorable
pricing? Answers to these questions require first identifying high credit quality
mortgage holders. The SCF does not have credit score information, so a proxy for
borrower creditworthiness was constructed. A high credit quality borrower,
therefore, is defined as one who has reported “not being behind 2 months or more
making loan repayments in the last year,” “not being turned down completely for
credit in the last 5 years,” and “never having filed for bankruptcy.”
After controlling for year of loan origination, degree of creditworthiness, and
borrower risk preferences, the results in Table 3 indicate pricing differences did exist
among high credit quality borrowers. The results also show that less than one-third
of high credit quality borrowers reported aggressively shopping for the best credit
terms. According to Table 3, 76% of all borrowers paying rates in the lower 25%
percentile of the normalized mortgage loan rate distribution were high credit quality
borrowers, and 63.3% of all borrowers paying rates in the upper percentile were of
high credit quality. Although the share of high quality borrowers in the top quartile
is smaller than the share in the bottom quartile, there is still a large share of
borrowers paying relatively higher loan rates, given their seemingly low levels of
credit risk.
Table 3. Rates Paid by High Credit Quality Borrowers on
Fixed-Rate Mortgages
^S^h^a^{re Bl}^ack^an^d
^Actua^l^Sha^{re H}ⁱ^g^h^Sha^{re H}ⁱ^g^h^Credit^Q^u^a^lit^y^S^h^a^{re Bl}^ack^an^d^Hi^s^p^anⁱ^c^Hi^gh^Hi^s^p^anⁱ^c^Hi^gh
^Num^b^er^Credit^Q^u^a^lit^y^Who^Sho^p^Credit^Q^u^a^lit^y^Credit^Q^u^a^lit^y
^B^o^rrow^ers^B^o^rrow^ers^A^ggres^sⁱ^vel^y^B^o^rrow^ers^Who^Sho^p
^A^ggres^sⁱ^vel^y
^B^o^tto^m¹⁷³^76.4%^29.7%^16.9%^27.9%
^Qu^ar^tile
^To^p¹⁴⁶^63.3%^29.3%^24.6%^41.6%
^Qu^ar^tile
^Source:^C^R^S^cal^cu^l^a^tⁱ^oⁿ^s^u^sⁱⁿ^g^t^h^{e 2004 S}^C^F^,^F^e^deral^R^e^s^e^rv^{e Board.}
Why did a large share of high credit quality borrowers have loan rates in the
upper quartile of the distribution? One explanation may be an increase in lending
practices resulting in borrowers only able to obtain high priced loans. Another
explanation may be that consumers did not aggressively shop for the best credit
terms. The results in Table 3 reflect a low degree of aggressive shopping by
consumers. Less than one-third of high credit quality borrowers report aggressive
shopping for the best credit terms, and the difference between the percentages of high
credit quality shoppers in the quartiles is still relatively small. Shopping may
arguably not matter for high credit quality borrowers in the bottom quartile, since
more than two-thirds managed to get better pricing without being aggressive
shoppers. The results in Table 2, however, suggest a strong incentive to shop did
exist, given that the interest rates in the quartiles were significantly different. Hence,
it may be surprising that fewer high credit quality households, especially those in the
top quartile of the distribution, reported being aggressive when shopping for the best

terms. Of course, respondents may have applied various subjective interpretations
of “aggressive” when answering the survey question, which could affect the results.
To what extent might discrimination explain the pricing differential? The
weighted percentages for Black and Hispanic borrowers have also been reported in
Table 3. Approximately 17% of the high credit quality borrowers in the bottom
quartile were black or Hispanic. Only 27.9% of the minority borrowers reported
shopping aggressively for lower terms, which was not much different from the
percentage of the entire sample. Almost 25% of the high credit quality borrowers in
the top quartile were black or Hispanic, and 41.6% reported shopping aggressively
for the best credit terms. Greater information on the credit shopping experiences of
minority borrowers would therefore be a useful component to further investigation
of this question. Minorities may have established fewer relationships with traditional
financial institutions and therefore be more likely to feel intimidated when dealing
with them. As a result, these borrowers might be more prone to shopping within the
universe of subprime lenders, rather than seeking prime lenders. In addition, a
disparate impact, which occurs when a practice or procedure has less favorable
consequences on particular groups, may be a factor. If minorities disproportionately
earn less income and accumulate less wealth, then loan-to-value and qualifying ratios
for these groups would be affected, which would likely affect loan pricing. Hence,
it is possible for minority borrowers who aggressively shop to pay higher loan rates
if their shopping experiences are vastly different from the majority population.²²
The data from the 2004 SCF suggests that less than a third of all homebuyers
shop aggressively for the best credit terms, which raises questions about consumer
judgment. Would disclosure reform have led to a reduction of subprime mortgage
troubles? On the one hand, if the mortgage shopping experience is frustrating under
current disclosures, enhanced disclosure may help motivate more consumers to
become more active shoppers. On the other hand, consumers who shop in a casual
manner for credit terms may not pay much attention to mortgage loan details
regardless how they are presented. As a result, it is difficult to determine whether
enhanced or expanded disclosure would help more people obtain affordable
mortgages, since consumers are not required to shop aggressively when making
financial decisions.

²² Discrimination cannot be proven using SCF data. Federal agencies follow Interagency
Fair Lending Examination Procedures, provided by the Federal Financial Institutions
Examination Council (FFIEC), to evaluate unlawful discrimination. The Department of
Justice, which investigates fair lending cases, establishes a pattern of discrimination before
charging lenders with violation of federal discrimination laws. The information necessary
to establish any patterns of discrimination is not available from SCF data. See
[http://www.dallasfed.org/ca/pubs/fair.html] and [http://www.ffiec.gov/PDF/fairlend.pdf].