Urban Institute recently identified a lack of small-dollar mortgages for single-family home purchases. When a shortage of these small loans is present, it is more difficult for those with sufficient credit to find affordable homeownership opportunities in low-cost housing markets, Urban Institute suggests.
The research indicates that the reason for low approval rates on small-dollar mortgages is because those applying for them face much higher denial rates. In 2015, about 80 percent of homes valued between $70,000 and $150,000 were bought with a mortgage, but about only about a quarter of homes below $70,000 were financed with a mortgage, hence the lack of small-dollar mortgages.
Contrary to what you may think, the high denial rate is not correlated with lackluster credit. “There is very little variation in applicants’ credit profiles by loan size: the share of low-credit-profile applicants was 34 percent for loans up to $70,000, 35 percent for loans between $70,000 and $150,000, and 30 percent for loans more than $150,000,” Urban Institute reports.
The conventional real denial rate, developed by Urban Institute to produce more accurate results, for loans $70,000 or less was 56 percent compared with the 45 percent for loans $70,000 to $150,000.
But why do small-dollar loans have the highest denial rates? Urban Institute produced three possible reasons why small-balance loans get denied so frequently.
- Many small-balance conventional loans are in rural and low-cost communities traditionally served by small banks and credit unions, which tend to originate only through the conventional channel.
- Bank originators, who originate fewer government loans, must comply with Community Reinvestment Act (CRA) requirements to meet the needs of the communities in which they operate, including the needs of low- and moderate-income neighborhoods. Many of these small loans would “count” for CRA purposes, giving banks an incentive that can compensate for the higher fixed costs of originating and servicing small loans.
- Borrowers who make large down payments generally choose the conventional channel because it offers lower rates for borrowers with lower loan-to-value ratios. When a borrower in that channel makes a large down payment on a home in the $70,000-to-$100,000 range, that loan will fall into the smaller, under-$70,000 category, contributing to the prevalence of small loans. Similarly, when a borrower chooses the government channel to take advantage of the smaller down payment for a similarly priced home, the small size of that down payment will move the loan outside the “small loan” category.
Ultimately, the high fixed cost of originating and servicing a loan is not worth the value of the loan, which inevitably makes it less attractive to lenders.