Mortgage Companies Should Discriminate

Lately, there have been several news stories chastising mortgage companies for taking new measures to discriminate among borrowers. Fannie Mae was the target of a few of these criticisms, for doing things like forbidding to back new loans from a strategic defaulters for seven years and from homeowners that have second liens from solar panel loans. In the New York Times Tuesday, there was another article meant to spark outrage among readers: some mortgage companies are making it more difficult for pregnant women to get mortgages. Instead of dismay, however, my reaction was relief.

All measures underwriters use to discriminate among applicants aim at the same end -- to limit the risk for providing a loan. So let's take Times example to consider whether or not it's a fair practice, since it might appear particularly egregious. The news probably evoked rage among many readers because society reveres pregnant women -- as it should. But although their decision to have a child is a wonderful thing, their state must be considered in a risk context by a loan underwriter.

Imagine the best-case scenario here from a risk perspective. You have a married couple with two disposable incomes that add up to $6,000 per month after taxes. And let's say their incomes are equal. They apply for a mortgage that would come out to $1,000 per month. In this case, the woman's pregnancy would be irrelevant. Even if one of the parents quit their job after the woman gives birth, $3,000 per month should be enough to pay the loan. A mortgage company almost certainly wouldn't have trouble with pregnancy in such a scenario.

Of course, this isn't the only possible scenario. Now imagine one where their total income is $3,000. The woman may plan to take three months paid leave for the pregnancy, and then return to work, putting the child in day care. That's all well and good, but plans can go awry or change. Having a child is a life-altering event. Maybe the couple was lying and one of them plans to stay at home with the baby. Or maybe they just change their mind once the child is born, because they can't bear the thought of putting their precious little one in day care. Why would banks imagine such possibilities? Because that's their job. Relying on people's promise to pay didn't work out so well for them over the past few years. Can you really blame them?

And even the best intentions can be thwarted by the unknown. What if the baby turns out to have birth defect and the family needs a full-time private nurse to care for the child? Suddenly, the woman quitting her job to stay home with the baby might be more sensible from a financial standpoint. With a one-parent income of $1,500 and a mortgage of $1,000, you can understand why the mortgage company wouldn't be pleased with such outcomes.

People became so used to banks providing a mortgage to anyone with pulse during the housing boom that, suddenly, prudent underwriting shocks and amazes. "You mean the bank wouldn't give a couple a mortgage because it's worried about significant factors that could affect their ability to pay? The horror!" In fact, this is a great sign. It means that banks and mortgage companies have learned something from their errors during the housing bubble. Sensible underwriting is making a comeback, and that's ultimately good for the U.S. economy.

And really, what's the cost of such measures? In the case of pregnant women, it means the couple might have to rent for another year or two, until their baby is born. Then, they can show the bank that the woman returned to work as planned and their income is more clearly stable. Although we live in a culture where "rent" is a four letter word, banks refusing to fund more mortgages over the past decade would have certainly left the economy in a much better state than it is in currently.