Incorporating Rental Housing Into Future Mortgage Market

This is the second of a two-part summary of the Center for American Progress (CAP)/National Council of LaRaza paper titled Making the Mortgage Market Work for American's Families (read part 1 HERE). In the first installment we summarized CAP's take on the current market challenges and the need for increased access and affordability and its analysis of the secondary market's role in promoting them. 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.

Rental Housing's Connection to the Secondary Mortgage Market.

Approximately one-third of Americans live in rental housing and nearly 50 percent of low-income renters and extremely low-income renters are minorities. As we restructure the mortgage finance system we must make sure that it directs capital to rental housing, especially affordable housing located in communities with access to good schools, jobs, and transportation.

The cost of rental housing is an increasing burden, especially for those with the least income. The Center for Housing Policy found that more than one in four renter households spent more than half their income on housing and in most places rents are rising faster than income.

Rental housing needs access to capital both for construction, to finance it when complete, and for periodic renovation. The government sponsored enterprises (GSEs) and the Federal Housing Administration (FHA) have a long history of supporting access and affordability in the rental-housing area and especially sustained it during the housing crisis. Even as private capital has returned to the multifamily market it has mostly focused on higher-end properties in the strongest urban and suburban markets, leaving government channels to finance older, less expensive properties and those in secondary and tertiary markets. For this reason, all discussions regarding the future of housing finance must include consideration of multifamily as well as single family financing.

Whatever solutions emerges as a structure on the single-family side likely will drive the outcome for multifamily finance simply because the former business is so much larger. Government should encourage whatever secondary market entities that emerge to devote a portion of their activities to rental housing, ideally with the goal of creating profitable, self-sustaining business lines.

Market Access Fund (MAF)

To this end, CAP proposes establishing a Market Access Fund, or MAF, to promote broader access to mortgage credit and to support the types of innovations that have proved successful in the past.  Over the years many potential homeowners who were once thought to be unacceptable risks have become successful homeowners through not only careful underwriting and targeted loan programs but because of limited amounts of credit enhancement or risk capital such as provided through FHA, the VA, and USDA's Rural Housing Services.

During their most effective years the GSEs did this using their own risk capital and setting standards for their lends; banks also participated, guided by Community Reinvestment Act (CRA) requirements. Because many of the proposals for a revamped housing finance system require the majority of the credit risk be borne by private capital which is not subject to CRA or GSE housing goals, the structure to support this innovation will probably not grow organically. For this reason it is critical to create a capacity for such credit enhancement such as MAF.

The MAF could be capitalized through a small assessment on all securitized mortgages (with or without a government guarantee). The monies would be used to support the development and testing of innovative, affordable products and services for approximately one to two million households annually.

The MAF would:

• Provide grants and loans for research, development, and pilot testing of innovations in prepurchase preparation, product, underwriting, and servicing that expands the market for sustainable homeownership and unsubsidized affordable rental.

Examples would be innovative automated underwriting systems, housing counseling, non-fee ownership structures such as community land trust and restricted deed sales which reduce the immediate entry price for homeownership while retaining permanent affordability. Other examples of innovation would be low-down-payment mortgages where a portion of every payment would go to a savings account to provide a cushion for repair/maintenance and economic distress

• Provide limited credit enhancement and other support such as financing for rehab and energy retrofits of small rental properties.

The MAF would also capitalize the Capital Magnet Fund, which enables Community Development Financial Institutions (CDFI) and nonprofit housing developers to attract private capital and take affordable housing and community development activity to greater scale and impact. The Fund was established by Congress shortly before the GSEs were placed in conservatorship and consequently has only received one round of funding. That 2010 infusion did result in funding of several successful projects.

MAF would also capitalize the National Housing Trust Fund, a HUD administered state block-grant program to increase and preserve the supply of rental housing for extremely low-income families. This Congressionally authorized fund was never funded.

Strategic Plans and Evaluation

In addition to providing targeted funding to expand the range of borrowers served by the housing-finance system, the system needs a mechanism to ensure against market "creaming" (lenders focusing resources first on the 'cream of the crop' borrowers)  . As in the case of our current housing-finance system, there must be a market regulator responsible for monitoring the use of the taxpayer guarantee, ensuring the public benefit is not abused or unfairly rationed. The regulator of the Secondary Market Entities (SME) would be in the best position to ensure that the benefits of a taxpayer-funded guarantee is available to all qualified borrowers.

While the accountability mechanism will ultimately adapt to the new housing-finance structure, CAP suggests one possible model with three key components; overall market assessments, rigorous oversight and evaluation, and individualized strategic plans.

Step 1. Conduct overall market assessment: The regulator would provide the public with an annual assessment of the housing market, identifying priority and unmet needs and areas that are underserved by the market such a senior or rural housing. Next the regulator would assess the potential causes of those gaps and offer insights and recommendations for closing them.

Step 2: Oversee and Evaluate SME Performance. The regulator would evaluate the extent to which the SMEs meet the housing needs identified in Step 1 and comply with fair housing and other laws. Other performance indicators would include the SMEs' ability to reach underserved communities, how effectively they assist borrowers to succeed as homeowners and whether the SME was appropriately deploying MAF money to support quality counseling, product innovation, and underwriting . Finally the regulator would ensure the SME loss-mitigation activities were effectively assisting borrowers to avoid foreclosure. The regulator would conduct a safety and soundness assessment to ensure that loans financed by the SME are affordable, responsible and sustainable and would have the authority to take remedial actions to address any problems.

Step 3: Build Individualized Strategic Plans. Each SME would design a strategic plan that would, in part, flow from the regulators assessment. It would use the planning process to identify specific housing and credit needs they intend to address, suggest innovative partnerships with other lending institutions, community organizations and public agencies and involve community stakeholders in the planning process and subsequent activities.

This continuous cycle of assessment, plans, and evaluations would create a rigorous but flexible accountability mechanism that would promote responsible lending and increased borrower support services. It could also initiate a dialogue among stakeholders regarding how best to address housing and credit needs.

The reports concludes that owning a home provides economic and social stability for the middle class, builds wealth that can be leveraged and transferred across generations and encourages residents to maintain their properties and invest in their communities. Affordable rental housing protects families against poverty, gives them more resources to meet other needs and can even provide an opportunity to save for a downpayment.

The secondary market plays a key rose in ensuring access for home buyers and for providers of affordable rental hosing. As we proceed with the national conversation about reforming the secondary market we can talk about its structure, the role of private capital, and how to minimize taxpayer risk but we must also address questions of access and affordability. If we keep all of these factors in mind we can design a secondary market that treats everyone equally and supports the type of broad, accessible, and affordable mortgage market that will best support American's families and its economy.