The Role of Information Asymmetry on Mortgage Loan Pricing: A Lemons Dilemma of Differential Pricing

Abstract

We utilize a set of models of differential mortgage cost that relies on the hypothesis of varying search costs driven by information asymmetry to examine pricing bias contingent on the racial composition of the neighborhood. Controlling for borrower and asset risk characteristics in a sample of fixed rate, prime loans we find that borrowers with comparable credit quality, but with housing located in neighborhoods with a high density of black and Hispanic households experience significantly higher costs of mortgage funds compared to neighborhoods with a high density of white residents. The results from this analysis suggest differential underwriter search costs for soft data that result in a lemons form of differential mortgage pricing regardless of the capacity of the borrower. When the pricing differential is controlled for in a model of mortgage default there is no support for the efficient/risk pricing argument.

Keywords: residential, mortgage, discrimination, information asymmetry, public policy, market efficiency

JEL Classification: G20, E44, D40, D45