Since 2008, the number of private secondary mortgage providers has reduced dramatically, and those that remain in the market generally purchase jumbo loans from more affluent borrowers.
Fannie Mae and Freddie Mac have been under government conservatorship since the beginning of 2008. Ginnie Mae is wholly owned by the federal government. This is important to note because most people believe that the government has no business competing with private enterprises unless it is there to serve segments of the market that are not being adequately served by the private sector.
While banks also have the capacity to make loans and hold them on their balance sheets, the majority sell most or all of their loans to secondary providers. They do this to reduce their risk and to free up their capital to process more loans. Independent mortgage bankers use lines of credit to fund all of their loans and therefore must sell them promptly on the secondary mortgage market. The bottom line is that the secondary mortgage market is the platform that powers the entire mortgage ecosystem in the U.S.
The benefit of a system with a robust secondary mortgage market is that borrowers can access competitively priced mortgages in almost every market in the country, and because the secondary market is limited to a handful of providers, the mortgage approval process is widely standardized. In other words, the process and criteria to qualify for a mortgage are very much the same throughout the country.
Without a strong secondary mortgage market supported by the federal government, lenders would be able to fund far fewer loans, and would likely flock to the most affluent areas in the country, leaving less-affluent markets with fewer options to finance a home. The drawback to having a uniform secondary mortgage market is that there isn’t much differentiation in the market. Because mortgage lenders need to underwrite their loans to satisfy either Fannie Mae, Freddie Mac or Ginnie Mae guidelines, every mortgage lender in every market offers much the same products and follows the same underwriting guidelines, making it difficult for mortgage lenders to serve borrowers who fall outside the narrow underwriting box.
Incentivize lenders to service more minority borrowers
Because Hispanic and Black borrowers typically have less wealth and are primarily first-time homebuyers, processing loans for minority borrowers can require more time and work.
Additionally, loans made to first-time buyers with small down payments are considered riskier and have higher rates and fees to compensate for the additional risk. Loans made to minority borrowers also tend to be smaller, so the commissions are lower. Essentially, loans made to Hispanic and Black borrowers frequently make less money, cost more to produce and carry more risk. The financial incentives are simply not there for mortgage companies that want to do more minority lending; therefore, it shouldn’t be a surprise that most banks and mortgage lenders do just enough minority lending to stay out of regulatory trouble but secretly have no desire to do much beyond that.
Fannie Mae and Freddie Mac have had affordable lending goals for years, but the impact of closing the minority homeownership gap has not been that significant. If the federal government was serious about closing the minority homeownership gap, they would require Fannie, Freddie and Ginnie Mae to provide financial incentives to lenders that outperform the market in lending to minority, first-time buyers. Today, a handful of companies make a disproportionate percentage of loans to minorities.
They do it despite the financial sacrifices, but their success proves that it can be done. Minority lending goals without financial incentives will continue to have modest outcomes, but if the financial incentives are aligned with the goals, lenders will respond accordingly and the impact on minority lending would be substantial.
How to safely qualify more minority borrowers
The U.S. is one of the few places in the world where you can get a fixed-rate mortgage amortized over 30 years. It is also a great product that would not be possible without our secondary market. Fixed-rate mortgages provide stability and predictability. The criteria to qualify for a fixed-rate mortgage has not changed much in the last 60 years.
Lenders use systems called automated underwriting systems (AUS) that are accessed by Fannie Mae and Freddie Mac. Income and credit information are inputted into the AUS. Then, it makes a decision based on three primary factors: debt-to-income ratio (DTI), credit score and loan-to-value ratio (LTV). Credit and loan-to-value ratios are fairly easy to determine for most people, but evaluating income is where judgment is sometimes involved. Today, for borrowers who do not get all of their income from fixed wages, their income is averaged over the most recent two-year span, making it more difficult for self-employed and part-time workers to qualify for a mortgage.
Latinos and other minorities are almost twice as likely to have self-employment or part-time income as the overall population. The emergence of the “gig economy,” where more people earn their money by working multiple part-time or temporary jobs, presents challenges for underwriters who are bound by a process that was designed when 90% of the population earned a standard paycheck. A borrower’s income should always be evaluated as part of the underwriting process, but closing the minority homeownership gap will require more innovation in determining income and the ability of a borrower to repay a mortgage.
Thin credit, when a borrower does not have enough established credit to generate a dependable credit score, is also an issue that tends to affect minority borrowers more frequently. Recently, Fannie Mae and Freddie Mac have allowed lenders to use rental history to build a credit profile. This is an important development because the data shows that a borrower’s history of paying rent or a previous mortgage is the single best indicator of a borrower’s ability to repay.
The consequences of risk-based pricing for mortgages
For the most part, interest rates for mortgages are determined by market forces; however, risk is also a factor. Ironically, higher interest rates and fees are assigned to the borrowers that can least afford them. This practice is called risk-based pricing. Borrowers with high loan-to-value ratios and lower credit scores are required to pay higher rates and fees for mortgages. This practice disproportionately affects minority first-time homebuyers. The most prominent exceptions to this practice are FHA and VA loans, in which everyone pays the same price and fees regardless of LTV or credit score.
Recently, the Federal Housing Finance Agency (FHFA), the regulator for Fannie Mae and Freddie Mac, made adjustments to their policies that reduced the pricing for loans that were previously deemed riskier. The policy initially received criticism from people who believed it penalized people with good credit. However, FHFA understands that homeownership rates, especially for minorities, won’t improve without addressing mortgage affordability for first-time buyers.
Diversity in the industry
If the industry was given one silver bullet to reduce the minority homeownership gap, it might be to substantially improve diversity in the mortgage industry. The process of purchasing a home is complicated and intimidating, especially for someone who has no experience with it. Having a mortgage professional who comes from your community, understands the cultural nuances and speaks your preferred language makes a huge difference. The mortgage companies that service the highest percentage of minority borrowers also have the most diverse teams — up and down their organization, from the C-suite to their operations and sales teams. Every year NAHREP surveys the top Latino mortgage originators in the nation. When asked why they chose the company for which they currently work, the No. 1 answer has been, “They understand my borrowers and know how to close my loans.”
Translation: my company employs people who look and sound like my clients and me.
Final words on access to mortgage credit
As our nation becomes a majority-minority country, our long-term prosperity depends on our ability to close ethnic wealth and prosperity gaps. Because home equity is the primary source of wealth for most Americans, closing the minority homeownership gap is the first step toward that goal. Closing the homeownership gap will require improving housing affordability, closing knowledge gaps, increasing diversity in the housing industry, and improving access to affordable mortgage credit. The latter can be accomplished by 1) Incentivizing mortgage lenders who originate a high percentage of their loans to minority borrowers, 2) Developing new metrics to determine the ability to repay, 3) Continuing to find solutions for borrowers with thin credit files, 4) Improve loan pricing for first-time homebuyers with average credit scores and small down payments, and 5) Dramatically improving diversity in the mortgage industry.
Gary Acosta is the co-founder and CEO of NAHREP.
This piece was originally published in the August/September 2023 issue of HousingWire Magazine. To read the full issue, click here.