April 2024

Soaring home prices are making homeownership significantly less affordable for American consumers, especially young and first-time homebuyers, with nearly 39 percent of Gen Z hopefuls citing saving for a down payment as their greatest obstacle.¹ While down payments are often the focal point of surveys and discussions, their role should not obscure the significant challenges posed by closing costs. Closing costs can be substantial—potentially amounting to a hefty percentage of the purchase price—and can be as much of a barrier to homeownership as down payments.

Down payment requirements offer a clear link between affordability concerns and macroeconomic forces like high prices, low inventories, and high interest rates. Closing costs, however, are less transparent but no less impactful. The mix of fees—appraisals, flood insurance, title insurance, and more—can create a confusing obstacle course for prospective homeowners, especially first-time buyers, making it difficult to save for these costs or make informed choices with respect to them. Today’s consumers are even less aware of how the evolving market landscape quietly shapes the loan costs they face. The recent retreat of large banks from the mortgage market has served to intensify the ongoing tilt toward nonbanks who originated 61.6 percent of all closed-end first-lien single-family home purchase loans in 2022.²

The diminishing presence of traditional banks in the mortgage origination market potentially sets the stage for an even greater concentration of nonbank lending. Decreased competition can in turn lead to increases in upfront fees.³ This evolving landscape could narrow borrowers’ choices and directly influence the fees they incur, making the selection of a lender a critical decision with significant financial implications. While many discussions on homeownership barriers focus on factors like race or housing supply, we believe that the role of lender selection also deserves attention, echoing a growing chorus of researchers who have raised similar concerns.⁴ This insight sheds light on how different lending models affect closing costs and the extent to which these costs vary across racial groups. Furthermore, we delve into how borrowers’ mortgage literacy and preferences influence decisions about lenders and, ultimately, costs to the borrower.

Data Build

We analyzed public Home Mortgage Disclosure Act (HMDA) data from 2021 and 2022. To classify lenders, we merged the HMDA data to a lender classification file—the “Avery File”—and grouped into three classes: Nonbanks, Banks/Credit Unions (combined as “banks” for simplicity), and Broker/Correspondent Lenders (“brokers”).⁵ We focused on 3.9 million 30-year fixed, conforming purchase loans for single-family primary residency. We excluded loans with unusual features like reverse mortgages or non-amortizing features.⁶

We focused on purchase loans for several reasons. Refinancings often involve rolling closing costs into the financed loan amount, making fee comparisons potentially unreliable. Certain non-depository lenders, like some fintech firms, primarily target the refinancing market segment, particularly nonprime, low-income, and minority communities.⁷ Comparing across lender types in the purchase market provides a more balanced view of competitive pricing strategies across different lenders.⁸

We combined HMDA, American Community Survey, and Credit Insecurity datasets to study relationships between income, race, lender type, and loan closing costs. We approximated closing costs by summing “Total Loan Costs” and “Total Points and Fees.” While HMDA has significantly improved in capturing lender fees, limitations remain. Expanded HMDA does not capture all out-of-pocket costs or offsetting credits received by borrowers. However, the enhanced data can still provide valuable insights into the impact of race and lender type on closing costs.

Background: Community Credit Insecurity Reinforces Structural Barriers

Rising prices and a high interest rate climate continue to move the target beyond reach for many aspiring homebuyers, especially those with low incomes struggling to save for or afford the costs of a mortgage. A tight market compounds financial pressures and constrains borrowers’ choices—both in terms of the lenders they can turn to and the availability of affordably-priced products to choose from. We used novel data from the Federal Reserve Bank of New York’s (FRBNY) Credit Insecurity Index to situate the complex web of challenges within local credit economies. Our analysis shows that borrower struggles with closing costs are not isolated but rather stem from systemic issues of credit availability and quality. We compute a closing cost burden as the proportion of a borrower’s income spent on loan fees. The measure highlights the degree to which these costs compound financial strain for borrowers, especially when considered in the context of credit insecurity.

FRBNY’s Credit Insecurity Index is designed to measure community financial well-being though the lens of access to credit, a financial asset that supports financial resilience.⁹ Beyond identifying “credit assured” and “credit insecure” communities, the index characterizes the local economy’s capacity to provide accessible credit products on fair terms. The binscatter plot depicted in Figure 1 indicates a clear correlation between average closing cost burden in a census tract and its level of credit insecurity. Borrowers in credit insecure communities face disproportionately higher closing cost burdens compared to those in credit assured neighborhoods. Increased closing cost burdens pose significant risk for borrowers with limited savings and low incomes. A larger share of income allocated to closing costs and down payments depletes vital cash reserves, heightening the potential for future delinquency and further entrenching the cycle of credit insecurity.¹⁰

These increased upfront liquidity burdens have also impacted borrowers’ credit eligibility. We analyzed rates of denials for insufficient funds to close and found a similar positive correlation with community credit insecurity. Higher rates of insecurity coincided with an increased incidence of denials due to the inability to afford down payments and closing costs.

Figure 1: Denial rates for insufficient closing funds & closing cost burden by credit insecurity

Denial rates for asset insecurity and closing cost burden are positively correlated with community credit insecurity.

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_{Data Source: Federal Reserve Bank of New York Community Credit Insecurity Index. The scores reflect the extent of credit insecurity across the U.S. The index measures populations not included in the formal credit economy and groups facing credit constraints.}

The correlation between credit insecurity and financial insufficiency suggests that a harmful feedback loop—exacerbated by unaffordable prices—makes homeownership increasingly inaccessible in areas facing high credit insecurity.¹¹ In these communities, credit insecurity not only limits access to homeownership but also hinders the ability to save for down payments or afford closing costs. In many ways, the patterns displayed in Figure 1 are a combination of borrowers’ financial circumstances and different policies that shape homeownership accessibility, particularly in credit-insecure communities. These trends not only point to affordability-driven barriers but also raise pressing questions about the mechanisms driving these dynamics, such as the pricing policies of different lender types and the choices borrowers make when purchasing a home.

Hidden costs of homeownership: Race, income, and lender differences in loan closing costs