When it comes to subprime lending, both race and space matter

by Jackelyn Hwang, Michael Hankinson and Kreg Steven Brown

Sometime in 2006, three women in similar financial circumstances bought homes in three different cities, each pursuing the American Dream that finally seemed within their reach. Sophia in San Francisco settled on a 2-bedroom walk-up in a working-class white neighborhood close to where she had been renting for years. She bought the unit with a conventional prime mortgage. Cathy in Charleston found a 3-bedroom craftsman near her current residence in a working-class majority-minority neighborhood. She also purchased her home with a conventional prime loan. Bianca in Baltimore fell in love with a 2-bedroom condo in a working-class section of the city’s predominantly minority West Side and within a few blocks of her parents’ house.

Unlike Sophia and Cathy, Bianca purchased her home with a subprime loan.

Why did Bianca get a subprime loan while Sophia and Cathy did not? With subprime lending booming across the country, what led to these different loans for otherwise similar buyers? Despite living in different cities, all three women bought homes in working class neighborhoods with moderate median incomes and homeownership levels.

The racial make-up of each neighborhood played a role in their likelihood of receiving a subprime loan.

Sophia moved to a predominantly white neighborhood where subprime loans were not all that common. In contrast, both Cathy and Bianca bought homes in high-minority neighborhoods where subprime lending was more typical. Still, despite buying in similar majority-minority neighborhoods, why did only Bianca receive a subprime loan? To understand why Bianca received a subprime loan and Cathy did not, we need to examine the racial composition of the surrounding neighborhoods.

Located in Baltimore’s West Side, Bianca’s minority neighborhood is surrounded by several other neighborhoods that are also over 50% black and Hispanic. The city’s long history of segregation created not just high-minority neighborhoods, but large swaths of interconnected majority-minority neighborhoods. In West Baltimore, and in similar minority clusters across the country, subprime lenders and brokers were able to set up shop and effectively market their products, not just to Bianca, but to her neighbors, coworkers, and even to people she had never met but just happened to live in the same segregated cluster of town.

The segregation of cities like Baltimore produced markets of large minority areas, which were more attractive to subprime lenders than isolated minority neighborhoods. The targeting of these markets by lenders left buyers such as Bianca with a much greater chance of receiving a subprime loan than her peers in the less segregated cities of Charleston and San Francisco.

The role of segregation in subprime lending

Research confirms that during the subprime lending boom in the early and mid-2000s, blacks, Latinos, and residents of black and Latino neighborhoods were more likely to receive subprime loans than whites and residents of white neighborhoods, even after accounting for socioeconomic differences.

Our study, published in Social Forces in 2015, builds upon this work. We too find higher rates of subprime lending in minority neighborhoods, but we also find that the concentration of those subprime loans in majority-minority areas increases with the level of metropolitan black and Latino racial segregation. Across the country, residents in black and Latino neighborhoods not only received more subprime loans than those in predominantly white neighborhoods, but this racial difference was magnified if they lived in a neighborhood in a city with more segregation.

Using a public registry of all loan applications in the US, we analyzed the location of all home loans issued in 2006—the peak of the subprime boom. We calculated the extent to which subprime loans were concentrated in majority black and Latino neighborhoods in the 100 largest metros in the US.

Results show that black and Latino neighborhoods in more segregated metropolitan areas had higher rates of subprime lending than similar neighborhoods in less segregated cities. Returning to our example at the beginning, minority neighborhoods in Baltimore have subprime lending rates that are over 5 percentage points higher than similar minority neighborhoods in San Francisco and Charleston.

How segregation matters

How did so many residents living in minority neighborhoods in highly segregated cities end up with subprime loans? In highly segregated cities, blacks and Latinos live in spatially concentrated areas with relatively low homeownership rates and both limited information and access to mainstream lending options. These isolated minority areas likely provided the necessary demand for subprime lenders and brokers. Meanwhile, their spatial concentration facilitated selling these products on the ground, making lending exploitation easy.

In contrast, less segregated cities tend to have smaller minority neighborhoods, surrounded by areas that are not majority-minority. These small minority neighborhoods by themselves were likely not large enough to create a geographic market with fewer competitors for lenders to exclusively target.

To be clear, we are not saying that segregation directly caused subprime lending, nor does our study examine the selling strategies of subprime lenders and brokers, but our findings suggest that segregation played a role in exacerbating the foreclosure crisis in minority neighborhoods. Predatory subprime lending and the consequent foreclosure crisis happened all over the country – in cities and suburbs, in places with and without diverse populations.

However, in large, segregated metros, lower quality loans were overwhelmingly funneled – and likely targeted – to those spatially contiguous areas with more minorities. Given borrowers of subprime loans are more than six times more likely to go into foreclosure than prime loans, it is not surprising that foreclosure rates were higher in metros with high levels of segregation.

Putting space back in segregation

Beyond our substantive findings, our study also utilized a novel measure of segregation. Social scientists use many techniques to measure segregation, each seeking to capture the extent to which distinct groups of people inhabit different spaces from each other. Yet, despite the importance of spatial proximity in why we think segregation has negative consequences, the most widely used measures of segregation do not directly account for spatial proximity. This shortcoming has limited our understanding of subprime lending and spatial targeting.

Imagine two cities: one with minority neighborhoods surrounded by primarily white neighborhoods, with each minority neighborhood a different area of the city; the other, segregated so that these majority-minority neighborhoods are clustered next to each other. Using the dissimilarity index, these two cities could have equal levels of segregation. However, subprime lenders and brokers may find the minority neighborhoods in the second city much easier to target and market their products. Our analysis captures these spatial aspects of segregation—the clustering of minorities into larger geographic areas.

Predominantly minority neighborhoods all over the country were severely impacted by subprime lending and the subsequent foreclosure crisis. Yet, those in highly segregated metropolitan areas fared worse. These neighborhoods, which already tended to be less well-off and more underserved, lost not only a tremendous amount of wealth, but the financial stability and upward mobility that wealth provides. The story of this loss is intimately linked with the spatial structure of our cities’ neighborhoods and how that segregation fosters continued disadvantage.

Jackelyn Hwang is a Postdoctoral Research Fellow in the Office of Population Research at Princeton University. Michael Hankinson is a PhD Candidate in Government & Social Policy and a Doctoral Fellow in the Multidisciplinary Program in Inequality and Social Policy at Harvard University. Kreg Steven Brown is a PhD Candidate in Sociology and a Doctoral Fellow in the Multidisciplinary Program in Inequality and Social Policy at Harvard University.

This article summarizes research published in “Racial and Spatial Targeting” in Social Forces.

Image: Basic Gov Foreclosure via Flickr (CC BY 2.0)