Are Small Mortgages Treated Differently?

Affordable, low-priced homeownership supported by mortgages is becoming increasingly challenging. In 2022, the Federal Reserve Bank of Philadelphia reports that small mortgage ($100,000 or less) originations fell by 28% in Pennsylvania, 43% in New Jersey, and 28% in Delaware from 2019 to 2021, for example. This trend hinders homeownership opportunities for relatively underserved communities, resulting in their continued status as renters rather than owners. We examine the underlying factors contributing to the lower approval rates for small mortgage applications by utilizing the Home Mortgage Disclosure Act (HMDA) dataset. Our preliminary findings, based on California data for the years 2021 and 2023, reveal that national commercial banks are 13% less likely to approve small mortgages (bottom 25% quantile mortgage size) compared to mid-sized loans (25%-75% quantile). Conversely, shadow banks (or mortgage bankers) exhibit no economically significant difference in approval rates. This discrepancy can be attributed to the contrasting organizational incentives of commercial banks and shadow banks. In general, the mortgage industry is structured so that larger loans generate more profits for originators and lenders. Commercial banks maintain diverse investment arms in addition to residential mortgages, allowing them to exercise greater selectivity towards larger loan offerings. Conversely, shadow banks that only engage in mortgage lending have limited capacity to be selective. Particularly in 2023, due to higher interest rates, borrowers’ debt-to-income ratios (ability to pay measure) have deteriorated. This heightened the borrowers’ default risk, disproportionately more for small mortgage borrowers. As a result, in 2023, local banks and credit unions also reduced approval rates for small mortgages, mirroring the trend set by national commercial banks.