Today’s post is the first of a two-part series on the link between demographic characteristics and the risk of loan delinquency.
Younger, less-educated and nonwhite families are much more likely to miss loan payments than older, better-educated and white families. Why is that?
Using data from the Federal Reserve Board’s Survey of Consumer Finances, researchers from the St. Louis Fed’s Center for Household Financial Stability tackled this question in an issue of In the Balance.
Senior Economic Adviser William R. Emmons, Senior Analyst Lowell Ricketts and intern Tasso Pettigrew examined whether "delinquency-prone" demographic characteristics underlie a greater "taste for risk," or whether these families are exposed to greater risk for reasons they did not choose and cannot control.
The authors found that families with certain demographic characteristics have a higher likelihood of becoming seriously delinquent—i.e., missing at least two consecutive payments—on a loan or other payment obligation.
The authors estimated that:
The authors noted that a potential explanation for why these differences exist is that delinquency-prone demographic characteristics correlate with a greater taste for risk. Under this hypothesis, such families are willing to accept higher risk-based interest rates and know that their credit scores will suffer if they fail to pay on time. Though the researchers found little evidence of a greater taste for risk, they decided to test that belief.
Emmons, Ricketts and Pettigrew adjusted for financial and personal choices and behaviors that might lead to higher delinquency rates. They explained: “In essence, the model answers this question: How much more likely is a randomly chosen young (or less-educated or nonwhite) family to encounter serious delinquency than an old (or better-educated or white) family if the young family made financial and personal choices exactly like those of an old (or better-educated or white) family and faced the same risks of income shocks, bequests or bad health?”
While eliminating so-called bad choices and bad luck reduced the likelihood of serious delinquency, it didn’t get rid of disparities except for Hispanic families.
The authors estimated that even if financial and personal choices, behavior and exposure to luck were the same as those of the lower risk group:
“Thus, demographic characteristics generally retain important predictive power for delinquency rates even after differences in observable choices, behavior and luck are taken into account,” the authors wrote. “This may be due to unobservable structural, systemic or historical factors or to experiences related to specific demographic groups.”
However, the authors questioned whether such an approach is realistic. They asked: “Can young families really ‘act old’? Can less-educated families behave as if they were highly educated, and nonwhite families simply choose to expose themselves only to the risks white families typically face?”
The next post explores an alternative method to understand the demographics of loan delinquency.