A Better Mortgage for Lower-Income Borrowers

The economic recovery has lifted values for many homeowners, but stagnant wages and tighter lending standards have locked many low- and moderate-income families out of the market. A pair of unlikely partners think it has a solution. On one side is Edward Pinto, a scholar at the conservative think tank American Enterprise Institute who has blamed the financial crisis on government affordable-housing policies. On the other is Bruce Marks, a longtime consumer advocate who founded and runs the Neighborhood Assistance Corporation of America. They’ve just launched a new program, which NACA is testing for Bank of America, to try to create a mortgage that’s both more affordable and less risky for borrowers and lenders.

Pinto says he and Marks started working on the idea after clashing on a panel in May. Pinto was skeptical of the typical way to help lower-income borrowers—reducing the amount of down payment on a 30-year mortgage. He says the housing crash showed that people who aren’t well-off can’t build equity fast enough in a typical 30-year loan, which makes them more vulnerable if the economy and home prices slump. “The volatility around one house in any given locality can be huge,” Pinto says. “We have put the people who can least afford the volatility into a house.” Marks’s nonprofit, on the other hand, is dedicated to helping low- and moderate-income people buy homes, often by helping them get loans with no down payment.

They agreed to meet and engaged in what Pinto calls “a very loooong, detailed conversation” about how to help people afford homes while they build equity faster. After the initial session, Pinto says, they “spent hours and hours and hours meeting and talking and outlining how this can done.” Eventually, they came up with a mortgage they call the Wealth Building Home Loan.

The key was to make it a 15-year loan, which allows borrowers to pay off the principal—and build equity—much faster and generally at a lower interest rate because shorter-term loans are less risky for lenders. Still, a shorter term also means higher monthly payments. To counter this, they looked for way to reduce the interest rate. The Wealth Building loan requires borrowers to have private mortgage insurance and restricts them from taking out a home equity loan. To enable borrowers to afford to pay “points”—an upfront fee that lowers the interest rate—the mortgage program allows loans to cover up to 100 percent of the value of the home, as opposed to the 96.5 percent cap in Federal Housing Administration mortgages. Pinto says he hopes some banks will cover the cost of points for some low-income borrowers as part of their community development programs.

In assessing creditworthiness, lenders typically focus on monthly payments as a percentage of borrowers’ income. Pinto’s program uses the so-called “residual income” approach that the Veterans Administration successfully uses. As I reported this summer, many economists prefer the VA’s approach, which adds up what a family spends on necessities such as transportation and child care and then looks at what’s left for housing. This approach to underwriting should make the loans less risky—which should, in turn, lower the interest rate.

Pinto says he’s in discussions with regional banks and mortgage lenders to start additional pilot programs. “In order to be a game-changer, you need to have a lot of people doing it,” Pinto says, pleased with the response he and Marks found when they announced the program at a recent conference. There, Joseph Smith, monitor of the $25 billion National Mortgage Settlement over faulty foreclosure practices, said in prepared remarks that after doing “a lot of listening” to borrowers, advocates, and public officials, he’s come to believe that “absent substantial home equity at the outset, the 30-year fixed rate mortgage increases the fragility of a borrower’s overall financial position and puts the borrower at risk for a very long time.” Smith praised the new program, adding: “Gentlemen, I tip my hat to you.”

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