Eliminating Credit Barriers to Increase Homeownership: How Far Can We Go?

Title: Eliminating Credit Barriers to Increase Homeownership: How Far Can We Go?

Date: 3/1/2001

Author(s): Anthony Pennington-Cross, Anthony Yezer, and Joseph Nichols

Executive Summary:

A simple question led to this study: What is the business potential of the underserved mortgage market? The 1990s saw record homeownership rates and major strides in closing the gap between majority and minority homeownership. Lenders also made inroads in increasing low-income homeownership. New marketing techniques and aggressive outreach certainly contributed to these gains, but a major factor was the availability of loans with increasingly higher loan-to-value ratios. Armed with more sophisticated underwriting standards, new product types, and a mandate for experimentation, the housing finance industry attacked downpayment and credit standards that constrained borrowing for many families on the margin of homeownership.
The increasingly leveraged character of lending to traditionally underserved borrowers raises a number of fundamental issues. How much higher can we raise homeownership rates by further attacking downpayment and other borrowing constraints? Do borrowing constraints truly exclude borrowers from homeownership, or do they merely serve to delay people from buying a home while they take the necessary steps to qualify financially?

To shed light on these issues, Dr. Stuart Rosenthal asks the following two questions. What happens to homeownership rates if we remove all borrowing constraints? And how do borrowing constraints affect a renter's expectation of becoming a homeowner?

The answer to the first question suggests that removing all borrowing constraints could increase the national homeownership rate by as much as 4 percentage points (67.4 percent to 71.4 percent). Dr. Rosenthal's research also suggests that, absent borrowing constraints, the percentage of renters who expect to become homeowners in the next five to ten years will increase by 7.6 percentage points (34.3 percent with no constraints versus 26.7 percent with constraints).The comparatively large increase in renters expecting to own may seem, on the surface, to explain the 4 percentage point increase in the national homeownership rate. However, renters only account for about one-third of the population. Thus, a 7.6 percentage point increase in renters expecting to own translates into only a 2½ percentage point increase in the national homeownership rate.

Dr. Rosenthal suggests that this difference in estimates-a 4 versus a 2½ percentage point increase in homeownership-provides indirect evidence on the frequency with which borrowing constraints serve to delay versus exclude families from homeownership. In the case of renter expectations, the 2½ percentage point estimate reflects families that would anticipate homeownership in the absence of borrowing constraints but that would otherwise be excluded from owning under present market conditions. The balance between the 4 and 2½ percentage point estimates, in contrast, may reflect renters who would simply speed up their purchases in response to easier access to financing. Breaking out households by race and ethnicity, the results suggest that borrowing constraints restrict access to homeownership at least in part by delaying home purchase for whites and Hispanics, while primarily excluding African Americans. This suggests that lenders can make further progress in closing the majority/ minority homeownership gap by continuing product and pricing innovation.

Dr. Rosenthal's research may also point to progress. With continuing concerns about discrimination, we might expect African American and Hispanic renters to have less confidence in their ability to become homeowners. Surprisingly, Dr. Rosenthal finds that minority and majority renters have comparably optimistic expectations about becoming homeowners, ranging from 23 to 27 percent. Removing borrowing constraints does not change this similarity in expectations (32 to 35 percent).

These results may indicate that the last decade of outreach and innovation has had an effect on minorities' expectations of owning a home, a hypothesis to be tested by further research. Sophisticated marketing techniques, more sensitive to differences in how people shop for mortgages, can help lenders capitalize on this optimism.

Other findings of this study suggest a way to make more fundamental progress in closing the homeownership gap. Dr. Rosenthal identifies economic and social stability as especially critical in explaining differences between majority and minority homeownership rates. This finding echoes other Institute research, such as Working Paper No. 00-02, The Decision to Own: The Impact of Race, Ethnicity and Immigrant Status. Whereas The Decision to Own found educational and employment opportunities to be directly important, Dr. Rosenthal identifies what may be the outcomes of more educational and employment opportunity as critical to closing homeownership rate gaps. Stability in such factors as health, marriage, and employment all-not surprisingly-give rise to a stronger preference to own.

We can derive three implications from this finding. First, policies that promote educational and employment opportunity can increase household stability, and therefore homeownership. Obviously, this is a broad policy agenda, and one beyond just the mortgage finance industry.

More significantly for lenders, this finding points to two possible courses of action to increase business opportunity. Further efforts to reduce borrowing constraints can lead more prospective homeowners to borrow sooner than they planned. However, this simply speeds up business that would have already occurred.

If we are to expand the market, we must reach those families now truly excluded by borrowing constraints. Lenders must develop a new generation of products addressing the realities faced by consumers who now, perhaps quite rationally, do not expect to own. For instance, significantly reducing closing costs can make homeownership a more rational choice for the mobile worker. Product innovations such as portable mortgages, under development by a number of major lenders, may reach households with no current expectations of homeownership.

We may be able to change the homeownership equation substantially by removing borrowing constraints. Nevertheless, even after lifting all borrowing constraints most renters (65.7 percent) do not expect to purchase a home. Dr. Rosenthal's research reminds us not to lose sight of the fact that many renters want to be renters.