Building Assets, Building Credit: Creating Wealth in Low-Income Communities

Chapter 2. Credit Matters: Building Assets in a Dual Financial Service System

10 Credit Matters: Building Assets in a Dual Financial Service System eric s. belsky and allegra calder 2 Since the publication in 1991 of Michael Sherraden’s seminal book Assets for the Poor, efforts have intensified to document the extent of asset poverty and devise strategies for ameliorating it. Interest in the subject derives not only from the importance of assets to individual well-being and economic security, but also from the extreme disparities in wealth found in the United States, disparities that eclipse even the wide income gaps between the rich and poor. By one measure of asset poverty, as many as 41 percent of all households in 1999 had inadequate savings or other liquid assets to cover their basic needs for three months (Caner and Wolff, 2004).1 Among those with the lowest incomes, asset poverty is even more severe. Fully one-third of all homeowners and two-thirds of all renters in the bottom-income quintile, for example, had $500 or less in savings and other liquid assets at last measure in 2001 (see figure 2-1). Attempts to build assets among the poor have concentrated on encouraging saving and promoting homeownership. Saving is seen as a necessary first step in building other assets and creating an individual safety net. Savings help insulate low-income households from temporary disruptions in income and spikes in expenditures, are necessary for making down payments on other assets, and 1. Caner and Wolff (2004) define a household (two adults and two children) as asset poor if the net worth of the current value of their marketable assets less the current value of their debts was less than $4,151. By this measure, 25.9 percent of families in 1999 were asset poor. Excluding home equity, the share rose to 40.1 percent. 03 7409-5 ch02.qxd 7/7/2005 10:09 PM Page 10 reduce reliance on costly short-term credit to make ends meet. Homeownership has been singled out for special attention for a variety of reasons as well. A highly leveraged investment, homeownership allows those with relatively small amounts of capital to earn large gains even if house price appreciation is only a few percentage points. Mortgage payments also constitute a form of enforced savings because a fraction of each payment goes to paying off the principal on the loan. In addition, homeownership provides opportunities to later borrow against equity at tax-advantaged and lower secured lending rates. On top of these attractions, well-situated housing can yield additional intangible benefits, such as access to jobs, better schools, and stronger social capital networks.2 Model of Influences on Mortgage Credit Terms Because virtually every low-income household must borrow money to buy a home, the emphasis placed on homeownership as the foundation of low-income credit matters 11 2. Assets are often classified as tangible or intangible. Tangible assets are financial and durable goods such as savings, stocks, bonds, mutual funds, homes, and vehicles. Intangible assets increase access to life chances and contribute to the ability to earn income and thus acquire tangible assets. Education, work experience, and social networks are examples of such assets. Figure 2-1. Savings and Liquid Assets of Low-Income Households, 2001a 20 40 60 80£ $2,000 in savings and liquid assets£ $1,000 in savings and liquid assets£ $500 in savings and liquid assets Renters Owners Renters Owners Bottom quintile Second to bottom quintile Households (percent) Source: Survey of Consumer Finances (2001). a. Liquid assets include transactions accounts, certificates of deposit, stocks, mutual funds, bonds, and savings bonds. 03 7409-5 ch02.qxd 7/7/2005 10:09 PM Page 11 asset building elevates the importance of credit and the system by which credit risk is assessed and priced. Until the mid-1990s, the creditworthiness of mortgage loan applicants was typically assessed by a manual review of credit records supplied by one or more of the centralized credit repositories. The only applicants to receive mortgages were those who had no or only modest past repayment problems. Today, the creditworthiness of loan applicants is assessed by statistically modeling credit records and correlating the resulting scores with the likelihood and severity of default. Although credit-impaired mortgage applicants are still often rejected for lower-cost prime loan products, most can now at least qualify for higher-cost subprime products. Mortgage credit access and pricing therefore rely on the quality of the...