Wednesday, October 15, 2008

Debunking the scapegoating of low-income homebuyers (Blog Action Day 2008)

It's disturbing how often you hear people blaming the subprime meltdown and financial crisis on low-income homebuyers and their supporters. It's bad enough to single out low-income borrowers for the exact same thing that happened all across the income spectrum-- people borrowing beyond their means, taking out a larger loan than was prudent. But there's also a whole bundle of false assertions and assumptions bundled into the accusations:

Myth: Most subprime loans went to low-income borrowers.
Facts: More than two-thirds of high-cost loans went to middle or upper-income borrowers (80% or more of median income) in 2006, with less than 8 percent to the lowest income group (50% of median income or below.) The Wall Street Journal analyzed the last decade of mortgage records and found that "the data contradict the conventional wisdom that subprime borrowers are overwhelmingly low-income residents of inner cities. Although the concentration of high-rate loans is higher in poorer communities, the numbers show that high-rate lending also rose sharply in middle-class and wealthier communities."

Myth: Low-income borrowers end up with subprime loans rather than prime loans because of their poor payment histories and high risk.
Facts: That plays a role but is far from the whole story. For one thing, an estimated 50 million Americans have no credit score thanks to a thin or non-existent credit history, and low-income borrowers are disproportionately represented in this group, which means they're often denied for prime loans due to their lack of "official" credit history rather than a history of payment problems. Yet studies have found that alternative credit scoring models (incorporating information like payment history for rent and utility bills) are just as accurate at predicting risk as traditional credit scores; a study of the "FICO Expansion" score found that more than 50 percent of thin-file/no-file credit applicants had scores under the alternative model that would qualify them for prime interest rates. (Not to mention the whole issue of deceptive, predatory, and fraudulent lending that's targeted to low-income people and minorities... Countrywide recently agreed to a more than $8 billion settlement after being sued for allegedly hiding fees, marketing in deceptive ways, and encouraging its employees and brokers to make risky loans.)

Myth: Subprime, high-cost loans are the only way to increase low-income homeownership, and the high foreclosure rates are inevitable given the risks.
Fact: Lenders who make an effort to responsibly promote low-income homeownership (rather than focusing solely on turning a profit), and the borrowers they lend to, are weathering the "subprime crisis" remarkably well. NeighborWorks America is a network of community organizations which partner with local banks to promote home ownership in low-income communities; only 0.21% percent of their mortgages entered foreclosure in the second quarter of 2008-- far better than the 4.26% of subprime mortgages beginning foreclosure in that time period, but also better than the rate of conventional mortgages (0.61%)! And while I haven't been able to find more recent numbers, in 2006 community development financial institutions wrote off 0.45% of their mortgage loans, compared to 0.39% for conventional lenders. While there are many factors in this success, it's clear that a key factor is the way the loans are structured; a recent study which looked at outcomes for subprime borrowers found that "all other characteristics being equal, borrowers are three to five times more likely to default if they obtained their mortgages through brokers. When the feature broker-origination channel is combined with the adjustable rate and/or prepayment penalty, the default risk is even higher."

Myth: Efforts to promote low-income homeownership, such as the Community Reinvestment Act (CRA), played a significant role in increasing the number of subprime loans and creating the crisis.
Facts: Only one of the top 25 subprime lenders in 2006 was subject to the CRA. By 2006, about 3/4 of subprime loans were made through brokers not regulated under the act. And as the President of the Federal Reserve Board of San Francisco put it in March 2008, "There has been a tendency to conflate the current problems in the subprime market with CRA-motivated lending, or with lending to low-income families in general. I believe it is very important to make a distinction between the two. Most of the loans made by depository institutions examined under the CRA have not been higher-priced loans, and studies have shown that the CRA has increased the volume of responsible lending to low- and moderate-income households." Besides, affordable housing advocates have been criticizing subprime and predatory lending tactics for years, not promoting them.

It would be a shame if the result of this crisis is less lending in the future to low and moderate-income families, especially considering that the crisis itself has had a devastating effect on many who refinanced with a subprime loand and are now losing their homes. Home ownership can be an important pathway to build wealth and improve quality of life for these individuals and families, and it seems clear that if it's done right it can be safe and profitable for lenders too.

I'm so proud that at a time when so many are running from low-income communities, my bank (ShoreBank) is using my savings account (with a healthy interest rate of 3.50% APY, by the way) to help struggling homeowners refinance their subprime mortgages and avoid foreclosure. If you want to fund responsible lending in low income communities, try banking with a community development bank or credit union (find one here.)


Sarah Ewing said...

Hi Penny,

We at ShoreBank are thankful for your wonderful blog defending the lower-income communities and the Community Reinvestment Act. I am on the Online Channel Manager specifically for our high yield savings account. I am thrilled to see the impact that a savings account can make on turning around this economy through the lower-income communities. If anybody is interested in what our executives think about this issue, the economy, or sustainable banking, check out our blog at or contact me!

Sarah Ewing
Online Channel Manager

Millionaire Mommy Next Door (Jen) said...

Bravo. Thanks for debunking these obnoxious myths with plenty of hard facts!

Skye said...

Thank you so much for writing this. Excellent resource.