Can the American Dream Leave No Family Behind?

Homeownership is now enjoyed by 68.1 percent of all American households—a new record....The 1990s saw increasing lending to low-income families and young families seeking their first homes. Lenders introduced special programs aimed at first-time homebuyers and revamped their underwriting standards to work with the special circumstances of low-income families. Private mortgage insurers, the FHA, Fannie Mae, and Freddie Mac also played important roles in what some observers called "a revolution in affordable lending." (U.S. Housing Market Conditions, 3rd Quarter 2001, November 2001)

Despite recent increases in homeownership opportunities, not all Americans can afford to buy homes. Low- income families may lack adequate income, savings, or both to qualify for even the most flexible, innovative financing. Two recent studies examine the potential and limitations of different financing tools to bridge barriers to homeownership.

"The Potential Limitations of Mortgage Innovation in Fostering Homeownership in the United States" uses mathematical simulation to demonstrate the impact of different financing strategies on homebuying capacity for different groups of renters. David Listokin, Elvin K. Wyly, Brian Schmitt, and Ioan Voicu assert that more innovative loans could qualify an additional 1 million renters for homeownership. The authors concede, however, that even the most flexible financing offers only limited potential to boost homeownership for low-income families.

In "Mind the Gap: Issues in Overcoming the Information, Income, Wealth, and Supply Gaps Facing Potential Buyers of Affordable Homes," J. Michael Collins and Doug Dylla explore income and wealth constraints as key barriers to homeownership and recommend different financing strategies for different groups of prospective homebuyers. The authors also assess the advantages and disadvantages of different financing strategies for borrowers and lenders and their potential for generating additional homebuying assistance.

The Limits of Innovative Financing

Although more flexible underwriting, first-time homebuyer programs, and other initiatives have increased homeownership, many low- and moderate-income (LMI) families are still unable to purchase homes. Both articles examine the limitations of different financing strategies for different groups of prospective homeowners.

Listokin and colleagues begin by examining the diverse impact on home buying of 10 existing mortgage models, ranging from the most restrictive (the Historical Mortgage that was the standard from 1970 to 1990), to more affordable and flexible financing (GSE Affordable Mortgages and Federal Housing Administration [FHA] Section 203 loans). By offering different financing and underwriting, these newer, more flexible mortgages, particularly FHA instruments, have extended homebuying capacity to about 1 million more renters. According to the authors, even though more flexible mortgages offer improvements over the Historical Mortgage, today's most liberal mortgage (FHA 203b) leaves about 80 percent of renters (at least 21 million families) unable to buy a low-priced home.

For minorities, the numbers are less promising: Between 3 and 9 percent of Black renters and 2 and 7 percent of Hispanic renters qualified for any existing mortgages. Listokin and colleagues emphasize that "[r]enters, in general, and minorities and LMI families, in particular, have very modest financial resources. This limits their home-buying capacity." As a mathematical model, this analysis does not consider lender bias because it treats all renters solely on the basis of their financial resources.

Collins and Dylla agree that a combination of income and asset barriers, rather than income alone, preclude renters from buying homes. According to "Mind the Gap," in 1999 a house selling for $97,000, which is 50 percent of the median price in the West, is unaffordable for families earning $27,000 (50 percent of median income). A family must have an income of $36,500 to qualify for this home. Even households earning the requisite $36,500 still need more than $4,000 in cash to cover downpayment and closing costs. These trends are similar for all regions of the country. However, the wealth gap is smallest in the South.

Each article uses current data to emphasize how both income and assets prevent low-income renters from qualifying for mortgages. Collins and Dylla state, "A third of renters in 1995 could afford monthly income payments but were prevented from buying a home because they lacked the wealth to cover downpayment and/or closing costs. Only 3 percent were constrained by income. The other two-thirds of renters who could not afford to buy a modestly priced home were prevented by a combination of inadequate wealth and lack of income." Listokin and colleagues reinforce these findings with data on minorities: Black and Hispanic renters have average family incomes of less than $20,000 and assets totaling less than $2,000. As a consequence, they lack the income and assets required to purchase a $100,000 home.

Collins and Dylla add that the transgenerational nature of poverty means that low-income families are less likely to receive gifts from their parents to help with downpayment and closing costs. This further increases the barriers to homeownership, given that 10 to 20 percent of average first-time homebuyers use gifts from relatives for downpayments.

New Financing Strategies Could Further Increase Homeownership

Both articles assess the potential of more innovative financing to make homeownership more affordable for low-income households. Listokin and colleagues simulate the impact by varying four key mortgage factors:

• Adjusting the mortgage terms, such as reducing interest rates and private mortgage insurance premiums.

• Decreasing transaction costs, such as closing costs and property taxes.

• Lowering the sales price of the house.

• Providing borrower financial supplements by adding income sup-plements of $1,000 to $10,000 or one-time asset transfers of the same amount.

The mathematical model shows how supplementing income, particularly by providing asset assistance, can dramatically increase homebuying capacity. For example, a $10,000 asset infusion would allow more than one-third of all renters, including 20 percent of Hispanic and 30 percent of Black renters, to afford modestly priced homes. By contrast, reducing downpayment and closing costs and decreasing the price of the house would have a smaller impact on increasing homeownership. Reducing interest rates to 2.5 percent would qualify only an additional 10 percent of all renters, an additional 2.7 percent of Black renters, and an additional 2.1 percent of Hispanic renters for homeownership.

Listokin and colleagues also consider the tradeoffs of different financing options. Although a $10,000 asset supplement would raise the share of renters who could afford a modestly priced home, the cost of this intervention would be $68 billion. Examining another tradeoff, the authors stress that more flexible financing might reduce downpayments, but it would also create higher monthly payments, particularly with added mortgage insurance to compensate for higher lender risk. Higher monthly mortgage payments, in turn, would reduce the amount of a family's available income to meet regular and emergency expenses.

Collins and Dylla agree that providing buyers with financial assistance is preferable to lowering interest rates or sales prices. The authors argue that this financial assistance should be structured as a second mortgage that simultaneously decreases the size of the first mortgage and helps overcome wealth gaps. Since these loans are subordinate to first mortgages, second mortgages carry higher risk. Therefore, for-profit lenders typically impose higher interest rates on these loans. However, many nonprofit lenders and state housing finance agencies offer second mortgages at below-market rates. These lenders are also more likely to be flexible about deferring payments in the event of temporary hardships. Another advantage of second mortgages is that nonprofit lenders typically establish loan pools to finance second mortgages. As borrowers repay the loans, lenders recycle these funds as second mortgages to another generation of low-income homebuyers.

Listokin and colleagues concur that innovative mortgage products and liberalized underwriting are only part of the answer to expanding homeownership. They share the conclusion of "Mind the Gap" that continuing partnerships among lenders, nonprofit groups, and the public sector are needed to sustain the impressive recent gains in homeownership in this country.

As both articles highlight, financing innovations, such as second mortgages, can open homeownership to more low-income families and raise U.S. homeownership above its current record of 68 percent. "Nevertheless," as Listokin and colleagues stress, "even the most aggressive innovations can play only a limited role in efforts to deliver the material benefits of homeownership to underserved populations."