Credit Access For Less Secure Borrowers Central to Housing Finance Reform

The Center for American Progress (CAP) and the National Council of La Raza have released a paper, Making the Mortgage Market Work for American's Families, which evaluates some of the problems facing the current mortgage market and presents challenges for its reform. The paper also presents a couple of concrete suggestions for reform including creations of a Market Access Fund to provide credit enhancement and supportive services to underserved but creditworthy populations and a framework for evaluating participants in an eventual new secondary market.

We are summarizing the paper's assertions in two parts. This initial article deals with an overview of current market challenges and the need for increased access and affordability and the secondary market's role in supporting this access and affordability. Part Two will look at the connection of rental-housing to the secondary market and CAP's suggestions for a Market Access Fund and a suggested model for evaluating the secondary market.

Current Market Challenges; The Need For Increased Access and Affordability 

America's housing-finance system is at a decision point. We can chose to restructure it to restore balance to the housing market and provide credit to a broad and diverse population, or we can live with a system in which credit and housing choices are more costly, more limited, and less sustainable, especially for minority and low- and moderate-income households.

The United States has a long history of unequal access to sustainable, affordable mortgages, particularly for minority and low- and moderate-income communities. Government programs such as the mortgage interest deduction disproportionately help those who least need it and creditworthy borrowers often have difficulty obtaining high quality mortgages. In the run-up to the housing crisis in 2007 many borrowers found themselves in "credit deserts" that left them few choices beyond subprime lending.

Lack of equal access to mortgage credit can be explained by a variety of factors, including not only traditional discrimination but also the failure of mortgage lenders to serve geographies and populations that they may see as less lucrative (known as market creaming).

While Congress has tried to level the playing field - through the Fair Housing and Equal Credit Opportunity Acts and other laws, minorities continue to have trouble accessing safe and sustainable mortgage credit. Additionally, different communities or borrowers have generally been served by different financial institutions and as a result face higher costs of borrowing and are more likely to be denied loans.

While the 2012 homeownership rate for whites was 73.6 percent, Hispanic and Africa American rates were 46.5 and 44.1 percent respectively. These differences significantly contribute to the dramatic wealth disparities between whites and minorities. The Urban Institute found in 2010 the average white family had six times the wealth ($632,000) as the average black family ($98,000) or Hispanic family ($110,000) and that lower homeownership rates and falling home prices were the key drivers of the gap. For this reason, it is critical to redesign the system to account for shifting demographics and changing consumer profiles, including the rapid growth of communities of color, decreased economic security, and increasing demand among rural Americans.

The Harvard Joint Center for Housing Studies projects that communities of color will account for more than 70 percent of new household growth between 2010 and 2020. Given the relatively low rates of homeownership among these communities, this demographic shift creates tremendous opportunity for lenders to expand into new markets.

Future borrowers are likely to be less economically secure and will also increasingly be low-wealth borrowers so the size of a required downpayment will be a crucial issue. Large downpayments are already a significant barrier to homeownership. Even with a 10 percent requirement it would take 20 years for the average family to save for a downpayment plus closing costs.

More future homeowners will live in rural areas where homeownership rates are already higher but residents still have few choices for accessing mortgage credit. In 2010 approximately 8.7 percent of rural originations were classified as high cost loans compared to 3.8 percent in the nation as a whole.

The nations housing-finance system needs to serve all of these populations and while these potential customers present some challenges, they also present tremendous opportunities for lenders to expand into new markets and threaten to make irrelevant those who don't.

Among these underserved populations are many people with the capacity to be successful homeowners. A recent study looked at these ostensibly risky populations who took out loans in 2010 and found that, despite their risk profile and the economic turmoil, these loans performed well with a serious delinquency rate 60 percent of the prime ARM portfolio and less than half that of subprime FRM.

The study attributed this success not so much to the borrowers but to the mortgage product itself. The lenders helped these nontraditional borrowers buy homes they could afford with mortgages they could manage. These success stories exist throughout the country.

Another obstacle to increasing access to affordable home ownership is "market creaming," the market's tendency to give preference to serving those perceived to be the easiest, most lucrative, or least risky borrowers - the so-called cream of the crop. Left to its own devices the market will tend to deliver the best loans where it is easiest to do so and to channel higher-cost loans where borrowers have fewer options.

Federal Reserve Chairman Ben Bernanke has suggested that the pendulum on lending standards has swung too far the other way and that overly tight lending standards may now be preventing creditworthy borrowers from buying homes and slowing the housing and thus the economic recovery. Bernanke said because there are no incentives to loosen lending standards, lenders are unlikely to do so anytime soon.

Unless policymakers reshape the incentive structure, the housing industry is likely to continue to chase the most lucrative loans at the expense of safe affordable homeownership opportunities for a wider spectrum of borrowers.

The Secondary Market's Role in Promoting Access and Affordability

Most people think of mortgage lenders as the point of intersection with the public. However the very large secondary mortgage market plays a critical role in ensuring access and affordability. Lenders prefer to make the types of mortgage loans that the secondary market will buy and so one of the most effective ways to ensure a broad, accessible, and affordable primary mortgage market is by creating a secondary market that promotes these same principles.

Unlike individual lenders with their constrained resources, the secondary market can quickly and effectively pilot new concepts and can take innovations emerging from the primary market and standardize them to reach a larger market and can quickly establish such a new product market.

The secondary market's policies regarding underwriting practices, documentation, risk-capital reserves, and repurchase requirements influence the behavior of the primary market and the secondary market can ensure credit is extended in a responsible way by well-capitalized entities. It is in an ideal position to monitor and counteract the primary market's tendency to service a narrower slice of the market through outreach, pricing, and counterparty management. Equally important, the secondary market can affirm and uphold the principles of fair and equitable access to credit.

To achieve an optimal balance between access to credit and safe and responsible lending any secondary market system should include mechanisms to incubate and support innovation around new products and processes that can expand homeownership both safely and profitably. Second, the system should discourage market creaming and encourage broad-based lending. Upholding these principles is the responsibility of the secondary market but also its regulators.