Establishing alternative methods of assessing credit and collateral could improve the rate of Black homeownership particularly at lower income levels, where racial disparities are currently quite pronounced, according to Urban Institute data.
For example, there’s about a 10 percentage point gap in homeownership of those with annual incomes of $150,000 or more: 80% for Blacks and 90% for whites. In contrast, for those who make $25,000 or less per year, the gap between Blacks and whites is 25 percentage points, with Blacks having a homeownership rate of 25% and whites at 50%.
There are many systemic challenges when it comes to small loans, and one of the most-cited ones is the fact that lenders make less money on them than bigger mortgages while paying the same amount to produce them.
Given that many lenders have been exceptionally profitable as a result of the recent origination boom, they might be able to absorb the cost of making some smaller loans more easily right now.
But they will have to be careful making sure those loans are made within the spirit of regulations that hold lenders accountable for borrowers’ ability to repay by making sure borrowers understand and can afford the long-term costs of lower-priced homes they buy.
One past Department of Housing and Urban Development program that existed before ability-to-repay regulations were established notoriously failed because it did not factor in costs of repairing or maintaining the houses involved.
The best way for a low-income homeowner to pay for repairs or maintenance may be to refinance and tap more home equity, but often the reluctance to make small-dollar loans precludes that as well.
A borrower may be able to get a small-dollar home loan through say, a special first-time home buyer program. However later, when the time comes to refinance the loan to pay for repairs, lenders may be even more reluctant to deal with the small loan.
In fact, when small loans are sold to the secondary market, a premium is often paid for them because investors are counting on the fact that they get refinanced less often. When loans refinance or prepay, it often diminishes the cash-flows from the investment to buyers, so they prefer to purchase loans where the cash-flow remains constant.
“This inability to leverage home equity and improve a deteriorating home feeds into a perpetual cycle that leads to long-term maintenance issues and persistent degradation of housing values, impeding how much wealth a homeowner will ultimately have,” the Urban Institute’s Housing Finance Policy Center noted in a recent report on small-dollar financing.
The institute has been working with Fahe, a Community Development Financial Institution, and the Homeownership Development Council of America on a “MicroMortgage” pilot project aimed at finding ways to address some of these challenges.
Strategies used in the pilot, which has initial funding of $2 million, include an appraisal alternatives to lower costs and underwriting based on rent payments rather than a more traditional credit history.
“It’s really about finding out what ancillary costs can be reduced and what different underwriting standards or parameters you could put in place that would enable doing more of this kind of lending,” said Alanna McCargo, a vice president at the institute and one of the report’s authors.
As the Louisville-based project enters its later phases, there may be opportunities for other lenders to encourage increased origination of small loans, said Linna Zhu, research associate at the institute, who also helped author the report.
“The main focus for phase one is new purchase loans, and for phase two we will look deeper into rehab and refinance,” she said. “In phase two, we also are planning to collaborate with more players to increase our scalability.”
