Savvy Refinancers Reinforce Mortgage-Market Inequality

Homeownership may be the American dream, but an increasing number of academics and policy makers say that as a wealth-building tool, it too often perpetuates inequality between people of different races, ethnicities, and economic classes. This dynamic is on stark display in homeowner refinancing patterns. Financially sophisticated households are quick to take advantage of better borrowing conditions, whereas less savvy households tend not to, whether because they’re unaware of such opportunities, unable or reticent to remortgage, or some combination of those factors.

The problem is amplified by the mortgage-origination process, according to a study by Duke’s David Berger, Northwestern’s Konstantin Milbradt, Fabrice Tourre of the Copenhagen Business School, and Chicago Booth’s Joseph Vavra. The researchers explain why this is, and why the problem can be so hard to solve.

Their work takes as its starting point a growing consensus that less-financially-savvy households refinance less often than those who have the know-how and wherewithal to access the most beneficial financial tools.

“People have argued, ‘This is a problem that’s generating inequality, and we should redesign the mortgage market to recognize it,’” Vavra says. But, he explains, many of the policy interventions that have been suggested so far don’t take into account the entire mortgage-market landscape, a flaw that may wind up being detrimental to all borrowers.

The researchers used loan-level, anonymized mortgage data from credit rating agency Equifax for the years 2005–17, sorting borrowers based on their attentiveness to changes in the marketplace and their opportunities to refinance. By comparing the existing interest rate on a loan with the prevailing market rate, they were able to gauge whether people missed out on opportunities to refinance when it would have been financially advantageous to do so. (Where possible, they controlled for complicating factors such as a homeowner’s low equity or low credit score.)

Attentiveness is one friction preventing a more efficient refinancing market. The costs associated with refinancing may also make it unattractive for some borrowers.

One popular reform proposal suggests that mortgages be designed to refinance automatically when certain thresholds are met. This might seem beneficial to borrowers for many reasons: Homeowners wouldn’t need to monitor mortgage markets and make a proactive decision about the right time to refinance, for one thing. Nor would they have to go through the process of comparing rates and putting in an application.

But the automatic-refinance approach, Vavra says, fails to take into account the likely response of lenders to the new market landscape. “If you’re changing around mortgage contracts substantially, it’s likely that lenders are going to change their behavior in response,” he says.