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November 07, 2007

Good Mortgages Still Going to Good People
    by Anne Moore Odell

Community development financial institutions and their customers across the country are disproving the idea that low-income people are mortgage risks. -- Homeownership is the backbone of the American dream. As the dishonest loan practices that preyed on the poor are being more widely disclosed, little has been made of the many low- and mid-income families who have successfully bought homes through a local community development financial institution (CDFI).

CDFIs in every area of the country are quietly doing what they have been doing successfully for years: helping lower income people find fair mortgages and supporting homeownership in communities that have been traditionally underserved by banks. Their innovative, yet solid, lending strategies are proving their worth despite this year’s subprime mortgage crisis.

"In each of our programs, we take the responsible, long-term view — ignoring the boom and bust cycles, the fads and the quick fixes," said Peter Carey of Self-Help Enterprises, in Visalia, CA. "We know that the real result of our investment in homeownership is seen in the lives of our participants, the future of their children, and in stronger, more productive communities."

Self-Help Enterprises (SHE) offers prospective homeowners an array of financial products and services. For example, SHE offers mutual self-help housing, a program that enables low-income families to qualify for financing on special terms through USDA Rural Development or California Housing Finance Agency. This program includes a mutual exchange of labor among these families to build each others' houses, which reduces the cost of the home and lowers the threshold to homeownership.

Hundreds of CDFIs around the country work to bring capital to the low-income areas they serve by providing banking, credit, and other services to people who might not have access to mainstream financial institutions. CDFIs can take several forms, including community development banks, credit unions, and loan funds.

CDFIs support their clients by offering technical assistance, below market rate loans, and other programs and mortgage products along side of traditional banking services. CDFIs themselves are supported through a combination of federal programs and tax credits from the US Department of Treasury and private sector investments and donations. CFDIs rely on thousands of donors and investors including foundations, churches, businesses, community groups, partners, and individuals.

Although investments in some CDFIs are not federally insured, most CDFIs are backed up by risk reserves created by the institutions to reduce the possibility of losses to their investors. With the mortgage scandal boiling over, it is important to note that CDFI created mortgages are not being hit by the same default rates as mortgages made by "sub-prime lenders."

To put default rates in perspective, the US Federal Reserve lists the default rate in residential mortgages for the first quarter of 2007 as 2.07% for loans through all banks. A report by Friedman, Billings, Ramsey, an investment bank with offices in Arlington, VA, states that as of August 2007 default rates on adjustable-rate sub-prime mortgages had reached 8.05%.

One of the most well known CDFIs is Self-Help Credit Union, with headquarters Durham, NC, (not to be confused with Self-Help Enterprises of San Joaquin Valley) had a foreclosure rate of 0.62% as of the end of September 2007, which mirrors many CDFIs’ default rates.

Self-Help Enterprises, which is not designed as a CDFI, holds mainly secondary loans, and the majority are deferred loans. Of the 145 deferred and 22 amortized loans in Self-Help’s own portfolio ($2.5 million), none are in default. Of the 1100 partner community loans that Self-Help manages, less than 1% are in default at any time.

One reason for the low default rates is that CDFIs know that the decisions around homeownership are not to be taken lightly. These organizations stress that the first step in having mortgage payments paid on time is creating a reasonable mortgage for all parties involved.

For example, the Berea, KY-based Federation of Appalachian Housing Enterprises (FAHE), has been successfully offering lower income people mortgages for over twenty years. FAHE targets families with incomes averaging $15,000. While the target used by federal government allows housing costs to account for up to 33% of a family’s income, FAHE has a 25% target. This helps make mortgages more affordable to their low-income population. FAHE almost exclusively uses 30 year fixed mortgages, which means there are no bait-and-switch repayment schedules like those that have crippled the sub-prime market.

"The only changes with our mortgages are with the families’ situations, for example, their employment or family size," said Jim King, President of FAHE. "We are consistent. We treat the mortgage payment like it is the most important payment to make every month."

SHE is similar in this regard. It does not allow adjustable rate mortgages (ARMs), option ARMs, interest only and other creative mortgages. As a result, SHE’s track record has been excellent with delinquencies and foreclosures primarily limited to those who have subsequently taken on additional debt or refinanced away from favorable terms in order to capture equity.

SHE also offers education and training to all households participating in its homeownership programs, as well as education and counseling to the broader sector of the low-income population in its lending area.

Another strategy used by CDFIs is financial counseling. In the Boston area, Aura Mortgage was launched this year by the CDFI Boston Community Capital helps educate its clients by working closely with them on determining how much they can borrow, it then lets the clients use the information to shop around at other mortgage companies.

"We believe this helps borrowers become better informed consumers by strengthening their financial acumen," said Richard Olson, President Aura Mortgage Advisors. "Our debt planning specialists are compensated in a way that ensures they are able to take the time necessary to educate their borrowers without feeling the need to ‘close the next deal.’"

Aura can reach populations that might otherwise be underserved with a staff that can speak English, Spanish, Portuguese, Cape Verdean, Wolof, and French to reach the broadest number of people possible. Aura believes that by putting the financial needs of the customer first, they can disrupt the subprime market in a way that forces lenders and brokers to re-think the approach to serving clients

The current subprime mortgage meltdown will certainly make it more difficult for low-income people to buy homes by tightening credit and underwriting. Yet there might still be a silver lining to the meltdown.

"Tightening credit and underwriting is not entirely a bad thing, since so many people have been led into unsustainable situations," Self-Help’s Carey told "I think we've seen the greatest risk coming from secondary lenders who capitalized on increasing property values and made it so alluring to cash out equity and compromise long-term security of the homeowner."

Aura Mortgage’s Olson agrees that the news about the sub-prime mortgages scandal is not all negative for lower income people: "With property values declining there are new opportunities for homeownership in communities that have been priced out of the reach of many first time home buyers. The tightening of the credit markets has nearly eliminated some of the "specialty" products that got homeowners into trouble."

Olson continued, "Pending legislative action and the market collapse have started to push out the rogue players that created the crisis. We are starting to see some product and practice innovations that are beginning to address the challenges of current homeowners in trouble."

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