Community Investments Vol 25, Issue 2
Uncertainty About Risk Keeps Mortgage Credit Conditions Tight
Despite some recent improvement in the U.S. housing market, mortgage lenders remain wary of all but the lowest risk borrowers, preventing many potential first-time homebuyers from entering the market. In their recent article for Moody’s Analytics and the Urban Institute, Jim Parrott and Mark Zandi discuss the reasons behind the consistently tight mortgage credit situation, and address how it might be remedied to allow more borrowers to secure a mortgage loan and keep the housing recovery on track.
Parrott and Zandi list several key reasons for tight credit conditions. First, lenders are avoiding high risk loans because many of them learned a painful lesson during the Recession about how expensive and time-consuming such loans can be to service; the average nonperforming loan is eight times more expensive to service than the average performing loan. Second, many lenders are only making loans to the best-positioned borrowers–by June 2013 the average borrower credit score was at a new high of 766–and funneling much of the rest of their resources into the home refinance market. While the increase in refinancing activity has been beneficial to the overall economy, the authors explain that in many cases, lenders are focusing on refinancing at the expense of the purchase origination side of their portfolios. Finally, Parrott and Zandi suggest that the most significant driver of the tight credit situation may be lender uncertainty about the higher risk loans they could be required to take back if Fannie Mae, Freddie Mac, or the Federal Housing Administration (FHA) discover any errors or noncompliance issues with these loans after the fact. The authors explain that Fannie, Freddie, and FHA guidelines about what lenders must do to ensure loan compliance are not always clear or consistently interpreted, increasing confusion and risk for lenders, who then avoid making loans to any borrowers they see as higher risk and more likely to default.
Overall, Parrott and Zandi stress that taken together, these factors create a substantial “risk blind spot” for lenders, against which lenders feel they cannot comfortably protect themselves from default and expense. As a result, these lenders are limiting their mortgage lending to the lowest-risk, most predictable borrowers.
Parrott and Zandi acknowledge that some of the issues behind tight credit conditions will only be resolved in relation to natural market shifts. For instance, the rise in refinancing activity is slowing down, and many lenders are returning their attention to new purchase loans. However, the authors also identify a role policymakers can play to help encourage lenders to expand their purchase origination loans to more borrowers. They suggest that Fannie Mae, Freddie Mac, and the FHA should work with lenders to make the process of reviewing loans to higher risk borrowers much more predictable for lenders, to reduce the number of loans for which lenders must cover the cost when problems occur. Reducing lender uncertainty in this manner, Parrott and Zandi note, could extend market access to more first-time borrowers and those with slightly lower credit scores, to keep the U.S. housing market recovery moving safely and steadily forward.
Parrott, Jim and Mark Zandi, “Opening the Credit Box,” Moody’s Analytics and the Urban Institute, September 30, 2013.
Los Angeles Area Exurbs Surprising Host to More Racially Integrated Neighborhoods
In research discussions, exurban communities are rarely seen as lands of opportunity. Rather, they are characterized in many cases as unfortunate byproducts of urban sprawl; places into which low- and moderate-income residents wishing to become homeowners may be forced as home prices and rents rise in urban core and nearby suburban areas. Yet a new study suggests that these exurban towns may feature an unexpected combination of inherent traits that allow for more racially balanced communities to form.
Deirdre Pfeiffer of Arizona State University interviewed 70 African Americans who moved from Los Angeles to exurban communities in Southern California’s Inland Empire region (Riverside and San Bernardino Counties), and analyzed Census Bureau data to determine the extent of and reasons for improved racial integration in these Inland Empire areas. She notes that between 1990 and 2007, African Americans moved from Los Angeles to suburban and exurban communities in large numbers, often to escape areas plagued with high crime rates and to find more affordable homeownership opportunities. While the residents Pfeiffer interviewed expressed that from their experience, the Los Angeles communities they migrated from tended to be racially segregated, they felt that the new Inland Empire communities they moved to were often much more racially heterogeneous, observations supported by Pfeiffer’s findings in U.S. Census and American Community Survey data. Pfeiffer also found that poverty levels between middle class white and African American residents varied by as many as eight percentage points in Los Angeles County, compared to a two percentage point gap in the Inland Empire.
Pfeiffer explains that a key reason for lower levels of racial segregation in the Inland Empire communities she studied is that they are recently-established neighborhoods developed in a tract style, rather than the infill development that is now more common in Los Angeles. If exurban neighborhoods are developed quickly, with the housing built all at once in subdivisions, those who move in are unlikely to know who their neighbors will be, so neighborhoods do not tend to be dominated by one race, a dynamic Pfeiffer’s interviewees noted was typical of their former Los Angeles neighborhoods. Another factor, according to Pfeiffer, is that those who move into the selected Inland Empire communities tend to earn similar mid-level incomes, making class more of a determining factor for residency than race.
Pfeiffer also identifies some important caveats. Improved racial equity, she notes, is not necessarily correlated with greater opportunity to build intergenerational wealth for people of color. The Inland Empire communities she studied have been among the hardest hit by the foreclosure crisis, which is a concern, Pfeiffer explains, because many African American homeowners in these towns have concentrated their wealth in their homes. Additionally, the general instability of exurban housing markets and the cumulative expense of the car-dependent lifestyle common in exurban communities may prevent residents of color in the Inland Empire from building long-term wealth.
In conclusion, Pfeiffer suggests that further study on exurban communities showing a similar trend toward improved racial equity in areas around Oakland, CA and Dallas, TX, among others, is essential to understand whether and to what extent these characteristics and caveats seen in the Inland Empire also play out in other exurban towns.
Pfeiffer, Deirdre, “Has Exurban Growth Enabled Greater Racial Equity in Neighborhood Quality? Evidence from the Los Angeles Region,” Journal of Urban Affairs, 2012, Volume 34, Number 4, pages 347-371.
The views expressed are not necessarily those of the Federal Reserve Bank of San Francisco or the Federal Reserve System. Material herein may be reprinted or abstracted providedis credited. Please provide our Community Development Department with a copy of any publication in which material is reprinted.