In the 1950s, it was common practice for banks to section off areas of their city as less eligible for loans. In essence, this was a form of racism. Poorer families, particularly black and Hispanic, would often struggle to get approved for a mortgage within these areas (source). Even if someone got approval, their mortgage often had larger down-payments and stricter repayment schedules.
This credit policy was called redlining, and the effects of it were devastating. Unsold homes fell into disrepair and were abandoned, property values fell, and life grew worse in the inner city. In essence, redlining simply exacerbated an already bad situation, stemming the flow of capital from the sole areas of the city that needed it most.
To address this problem, the Fair Housing Act was signed into law by President Lyndon Johnson as a part of the Civil Rights Act of 1968. This law basically made it illegal to deny someone a mortgage based on their ethnicity. This law was strengthened by another piece of regulation: The Community Reinvestment Act, signed by President Carter in 1977. This second law now required banks to have their lending practices periodically reviewed by the US government to make sure they kept in line.
I am a big fan of the Civil Rights Act of 1968. Millions of at-risk families have been helped by this law. That said, I am also a big fan of a new version of redlining, a smarter more modern derivative of its ugly racist former self.
Redlining in 2014 via Peer to Peer Lending
As many people know, the emergence of peer to peer lending in 2006 gave average Americans the ability to issue loans themselves. In peer to peer lending, an investor has the credit history of a prospective borrower laid bare before them. And while race is (thankfully) not included, a lot of personal descriptors still are. Most interesting is the presence of a borrower’s geography. And here is a fascinating thing that has come to light: certain areas of the United States have a lower rate of return than others.
Particularly Florida. Folks from Florida are less likely, in a statistically significant way, to pay back their p2p loans. So I have never loaned a dollar to people in Florida, and have gone on to earn a higher net return on my peer to peer investment than 90% of p2p lenders.
Let’s look at some juicy data from Lending Club (pulled today from NSR):
The above chart shows a couple of things. In the top box we see the entire return of all the loans in Lending Club’s history, $3.3B in issued dollars spread across almost 250,000 loans. The overall return for Lending Club? 8.68%
The bottom chart is where things get interesting. It lists the ROI by state in ascending order (excluding states where too few loans have been issued for a valid number). Basically, it shows the states at Lending Club that are the least likely to pay back their loans. And at the top of the list (and by a wide margin) is Florida with an overall peer to peer lending ROI of 7.17%, a full percent and a half lower than the national average.
Why Are People in Florida More Likely to Default on their P2P Loans? A Glance at Mortgage Habits
I. Floridians are twice as likely to be late on their mortgage payments
As seen in this beautiful graphic by TransUnion (60-Day Mortgage Loan Delinquency Rate by State), one out of ten Floridians are late on their mortgage payments (9.87%). This is more than twice the national average, which is pegged at 4.09%. The closest behind is Nevada and New Jersey in the mid 7s. Everybody else is below 6%. This isn’t a new trend either. Here is an article from Bloomberg talking about Florida’s staggering 17% late mortgage rate in 2012.
II. Floridians are 2nd for being underwater on their homes
A house is deemed as underwater when people owe more on it than its current market value, and this typically happens to people who borrow against their mortgage right before housing prices fall. More interestingly, it typically happens to geographic areas that keep borrowing against their house instead of paying it off. Florida is second in the United States in this regard, with 38% of its mortgages currently underwater (USA Today).
From the same article:
In New Jersey [...] borrowers in the foreclosure process haven’t made a payment for an average of 934 days, according to Lender Processing Services Inc. (LPS) New York, at 953 days, and Florida, at 938 days, are the only states with longer time frames. The U.S. average is 742 days.
III. Florida homes are twice as likely to be repossessed
Even though the rest of the United States has somewhat recovered from the massive housing bubble of 2008, Florida has not. It is still languishing with the highest rate of repossession nationwide (see: Florida Defies Housing Rebound as Foreclosures Soar via Bloomberg).
How Mortgages Compare to Peer to Peer Loans
If you think about it, it would make sense that people would repay their mortgages in a similar way to repaying their peer to peer loans. After all, both are fixed-rate amortizing lines of credit to prime borrowers. The same cannot be said about credit cards (though Florida seems to have high credit card delinquency rates as well), since they are sometimes issued to people with bad credit.
The national map for states that are more likely to be late on their credit cards corresponds more with poverty rates. Here are the states most behind on their credit cards:
- West Virginia
- Arkansas (source: the ‘Credit Cards’ tab here)
The 5 poorest states in the US?
- West Virginia
- Alabama (source: Wikipedia)
Note: you can see further evidence of this in the list of peer to peer state ROI above. The average rate given on a peer to peer loan for Alabama is higher than the rest, meaning the borrowers there generally have lower credit scores.
In essence, when comparing only the people who get mortgages and peer to peer loans, we are talking about a similar population of borrowers with decent credit.
Or so it seems.
Why Floridians Are More Likely to Default on their Loans
The reasons why Florida is more likely to default on their loans is subject to debate. After all, we are making a generalization here about the financial habits of 20 million people, so it is probably important that we tread lightly with what we say next.
That said, let’s begin with a question: why doesn’t the map of states behind on their mortgage payments mirror the poverty map? After all, the states late on their credit cards corresponds with states in poverty, so why doesn’t it correspond with late mortgages as well?
The answer: getting a home loan requires good credit, and people in Florida are more likely to seem like they have good credit when, in reality, they don’t. To put it another way, issuers of both mortgages or peer to peer loans are less able to predict risk for people in Florida.
This leads us to the final question: why are credit scores soft in these regions?
The Frenzied Culture of Florida, California, & Nevada
What I am about to say next is only my opinion: I believe the reason why credit scores are less accurate in Florida has to do with the state’s culture. Even though a person may have perfect credit (no late payments, bankruptcies, etc.), the surrounding culture is one that is encouraging them to borrow beyond their means – to build a bigger house than they can afford, or to borrow more money than they can repay. And this cultural influence is going to make credit scores a less accurate prediction of repayment.
This was evidenced in 2008 by the mania of approved-mortgage construction in Florida, particularly when coupled with the volume at which these new houses were repossessed:
The historic boom and subsequent decline in the nation’s housing market has been a defining feature of the current recession. The housing downturn has been most acute in four states—Arizona, California, Florida, and Nevada—that had experienced some of the highest rates of home price appreciation in the first half of the decade. (The Sand States: Anatomy of a Perfect Housing-Market Storm” FDIC.gov 2009)
In short, FICO does not weigh Jacksonville. Good credit scores on paper in these four states do not account for the fact that they exist in a boom and bust geography.
However, even though mortgage issuers ignore a person’s geography does not mean we have to as well.
Why I Never Lend Money to Florida
In summary, the data seems to indicate that prime-rated Floridians (followed by California & Nevada) are more likely to be financially irresponsible than people in other states. This does not mean all people in Florida are this way, but when aggregated, this is the picture that is painted. And while I find it ridiculous to deny a loan because of a person’s ethnicity, I find some sort of justice in redlining geographies that live beyond their means.
Using the Portfolio Analyzer on NSR, I’ve placed a pin on every city I have loaned money to at Lending Club. An interesting picture has begun to emerge:
The result of this practice? An overall return at Lending Club & Prosper that is greater than average:
Conclusion: The Joy of Redlining
Peer to peer lending presents us with a tremendous opportunity. For starters, we have the ability to amp our returns by avoiding geographic parts of the country that are historically less likely to repay p2p debts. Perhaps more importantly, we have the ability to inject a small bit of reality into the so-called Sand States, the areas of the country that contain higher prime-rated financial irresponsibility. Hopefully, with less credit available to them, and subsequently with less of an ability to take wild risks, these bastions of boom and bust will be relegated into humbler, healthier, more responsible versions of their former selves.