Increasing Access to Small Dollar Mortgages: Potential Solutions

Understanding the challenges facing potential buyers in need of small dollar loans, and how these challenges interact with one another, allows us to assess existing solutions and develop new ones that take into account the full scope of the issue. While this report does not include a comprehensive discussion on potential solutions, we raise ones that are particularly relevant to the challenges laid out in this report, at both a local and national level.

Before getting into the solutions, it is important to note that many of the challenges that buyers are facing do not stem from the small dollar mortgage market or even the housing system. In today’s highly competitive market, part of the challenge is that the playing field is stacked against low- and moderate-income buyers not only because of a lack of financing, but because these buyers do not have extra cash on hand to compete or conduct repairs, due in large part to stagnant wages and skyrocketing rents. If homeownership is becoming a game of how much a buyer is willing to risk, what happens to those who cannot afford to take such a risk? They are increasingly left behind.

Ultimately, it takes money to compete for a home, and thereby build wealth, which in turn leads to more money. When asked about the most promising solutions for low- and moderate-income buyers in Forsyth County, it is perhaps unsurprising that many responded with the same thing that has kept many low- and moderate-income buyers out of the market for homeownership in the first place: more money.

As discussed, regulations implemented in the aftermath of the Great Recession may be disincentivizing lenders from writing small dollar mortgages. Streamlining the mortgage loan process and creating new loan products to accommodate small dollar loans would help ease the flow of mortgage credit and is an important component of a robust federal and local response. The existing mortgage system is long and prohibitively expensive. By automating the underwriting process and reducing the time it takes to review borrowers’ finances, costs may be reduced, allowing more lenders to offer smaller loan sizes.

Most mortgage loans issued in the United States are made by non-bank lenders, including credit unions, community development financial institutions (CDFIs), and other mortgage lending companies. The same is true in Forsyth County: according to 2019 HMDA data, nearly 75 percent of loans were issued by non-bank lenders. Whereas many lending institutions are unable or unwilling to write mortgage loans below a certain threshold, some financial institutions like credit unions offer flexible financing terms that make them more favorable to extending small dollar mortgages.

According to one Forsyth County lender, credit unions have greater flexibility in their lending practices, enabling them to offer more accessible products than banks, such as 100 percent financing home loans and portfolio loans. However, knowledge among real estate agents in Forsyth County that credit unions may offer products not offered by banks is not widespread, and the barriers to entry are higher for credit unions than for banks. Credit unions are one example, but there may be other sources of funding for local banks and CDFIs to support small dollar lending.

Alternative loan products may also be a viable avenue for redressing existing barriers to financing a mortgage. For example, the Neighborhood Assistance Corporation of America (NACA), which formed amid the fallout of the 2008 financial crash, disregards loan applicants’ credit scores and offers below market interest rates.

Some banks which initially shied away from small dollar lending after the passage of Dodd-Frank have since returned to the small dollar market with revised loan products. One agent discussed the Community Homeownership Incentive Program (CHIP) loan product offered by Truist Bank, designed for lower-income neighborhoods. If eligible, “they offer 100% financing which is actually better than what FHA is offering.”

And given the major decline in FHA small dollar loans and the important role they serve, revisiting FHA processes to ensure the agency is serving its intended purpose is critical. This includes ensuring a wider array of options for purchasing and renovating older homes and homes in need of repairs, both through FHA and other loan products.

In direct response to redlining and other discriminatory practices, the 1977 Community Reinvestment Act (CRA), is intended to guide commercial banks towards serving the credit needs of low- and moderate-income communities. The CRA holds a lot of potential to leverage the role of banks and other financial institutions to ensure that the needs of homebuyers looking for small loans are met.

At the same time, agents, lenders, and housing experts in Forsyth County, reported that, in actuality, some “[banks] are doing what is required but they are not doing what the spirit of the CRA intended.” In some cases, financing new development in low- and moderate-income communities is sufficient to satisfy CRA requirements, even if it is unclear whether this development constitutes community reinvestment as outlined in the CRA. In other cases, banks can hold community events and other outreach initiatives, suggesting that there are several non-lending related ways that banks can meet CRA requirements that may not manifest in wealth-building opportunities.

Certain banks have offered programs for qualified borrowers in order to meet CRA requirements, such as a 100 percent financing home loan with no mortgage insurance or down payment, suggesting that leveraging the stipulations of the CRA could be an effective means of compelling banks to accommodate low- and moderate-income borrowers, but may not be utilized to its full extent.

Certain banks operating in Forsyth County have offered programs for qualified borrowers in order to meet CRA requirements, such as a 100 percent financing home loan with no mortgage insurance or down payment. This suggests that further leveraging the stipulations of the CRA could be an effective means of compelling banks to accommodate low- and moderate-income borrowers, though it may not be utilized to its full extent.

The small dollar mortgage market relies on several different players, all acting according to a different set of incentives. Just as lending institutions take into account profit margins when considering whether to process small dollar loans, real estate agents must also consider the value of their time when contemplating whether to take on small dollar and other lower-cost homes. And for agents working at a 2.5 percent to 3 percent commission, the payout on a home below $100,000 may not be sufficient to make their effort worthwhile. As one agent observed, “it’s the same amount of work for a $100,000 house as a $300,000 house,” but the demands of working on small dollar homes in a competitive housing market, where everything needs to occur as quickly as possible, can be much more intense.

Homeownership for low- and moderate-income families increasingly hinges on the goodwill of local institutions and individual actors, who act on behalf of the greater good, rather than their own profit incentives.

In some sense, access to homeownership for low- and moderate-income families hinges on the mission-driven values and goodwill of local institutions and individual actors, who make decisions on behalf of the greater good, rather than their own profit incentives. While this is indeed admirable, it is not sustainable—any profits based on a percentage of the value of the home or size of the loan will result in a misalignment of incentives and a suboptimal outcome. Instead, there needs to be opportunities to incentivize lenders and agents to work with small dollar homes or loans. An up-front monetary incentive for agents and lenders is one way to mitigate the disincentives to working with small dollar transactions.

On the buyer side, one option would be to consider implementing incentives for lenders to work with low- and moderate-income homebuyers, to even the playing field with more expensive loans. One example is expanding “first look” programs, which provide first-time homebuyers and low-income borrowers an exclusive opportunity, typically around 20 days, to purchase homes before investors can compete. Similarly, incentives from local governments or banks using CRA funds to offset the relatively higher costs of small dollar mortgages may make the loans more attractive at the individual mortgage broker level.

Lastly, the Dodd-Frank banking regulations designed to protect low-income borrowers should be revisited. The unintended consequences of caps on closing costs may have led to many commercial banks shying away from lending small dollar loans. We have hypothesized that the consequences of this have led to widening wealth gaps between whites and Black and Hispanic families, as well as potentially increasing the concentration of poverty in neighborhoods in Forsyth County, as well as many cities across the country.