Why Are Some People More Delinquent on Loans Than Others?

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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:

• A family headed by someone under 40 years old is 5.0 times as likely to become seriously delinquent as a family headed by someone 62 or older.
• Middle-aged families (those with a family head 40 to 61 years old) are 3.7 times as likely to become seriously delinquent as an older family.
• A family headed by someone with at most a high school diploma is 2.5 times as likely to become seriously delinquent as a family headed by someone with postgraduate education, i.e., schooling beyond a four-year degree.
• A family headed by someone with at most a four-year college degree is 2.4 times as likely to become seriously delinquent as one headed by someone with postgraduate education.
• A black family is 2.2 times as likely to become seriously delinquent as a white family.
• A Hispanic family is 1.6 times as likely to become seriously delinquent as a white family.

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:

• Young families would be 1.8 times as likely as old families to become seriously delinquent, and middle-aged families would become seriously delinquent 2.1 times as often as old families.

• Families with at most high school education or at most a four-year college degree would remain about 1.4 times as likely to become seriously delinquent as families with postgraduate education.
• Black families would become seriously delinquent 1.4 times as often as white families.

“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.

• In the Balance: Choosing to Fail or Lack of Choice? The Demographics of Loan Delinquency
• On the Economy: To Borrow, or not to Borrow?
• On the Economy: How Consumer Debt Has Evolved in the Nation and the Eighth District