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

PART 2: Beyond Prime

2 part Beyond Prime edward golding Technology has driven two changes in the mortgage market, consolidation in the industry and use of automated underwriting to assess quickly and at low cost the risk of borrower default. For many borrowers, the changes have been unambiguously good. Low-cost mortgages are available with little hassle. These borrowers, who are likely to be proficient in dealing with financial institutions and have good credit, are considered in the prime market. For others with less financial sophistication or blemished credit, the changes in the mortgage market raise important policy issues. There are roles for both government action and community-based organizations in addressing these policy issues. The chapters in Part 2, by William Apgar and Allen Fishbein, and by Michael Collins, Eric Belsky, and Karl Case, provide important insight into these policy issues. The development and widespread adoption of automated underwriting during the 1990s has transformed the mortgage finance industry. By automating a previously manual loan evaluation process, automated underwriting created scale economies and other efficiencies that reduced mortgage costs. By enabling lenders to measure better the likelihood of default, automated underwriting expanded access to mortgage credit. With better tools to measure risk, lenders reduced down-payment requirements and expanded credit availability, which, along with a strong economy, has been a key contributor to America’s increased homeownership rate. By making underwriting guidelines easier to implement, automated underwriting facilitated the proliferation of mortgage brokers and 103 07 7409-5 pt02.qxd 7/7/2005 10:11 PM Page 103 104 beyond prime 1. In the conventional prime market, less than 40 percent of borrowers have below-median incomes. Source: 2002 HMDA data and Federal Reserve Board’s 2002 HMDA lender file. third-party originators that, in turn, has lowered costs and increased consumer choice among mortgage products and providers. In the conventional prime market, most mortgage applications are evaluated using automated underwriting systems. The following chapters explore the challenges posed and the opportunities presented by expanding automated underwriting more fully into nonprime, nonconventional markets. Over 50 percent of borrowers in the subprime market and 70 percent of Federal Housing Administration (FHA) and manufactured housing borrowers have incomes below the area median family income.1 While these markets may be meeting the needs of certain borrowers, there is empirical evidence that borrowers in these markets could benefit from additional choice and the lower costs of the prime market. Therefore, the opportunities for expanding access to mortgage credit in nonprime markets are substantial and disproportionately can benefit lowerincome families. Against these benefits, automated underwriting in nonprime markets poses challenges and raises thorny public policy questions. Foremost is the question of whether the move toward credit scoring and risk-based pricing in nonprime markets would result in a more equitable and socially desirable allocation of mortgage credit. Other policy issues arise out of concern that some borrowers and organizations that thrived under manual underwriting may be disadvantaged by the growing role of automated underwriting. Apgar and Fishbein describe the organizational changes that have taken place in the mortgage industry during the last several decades—regulatory change and ensuing consolidation in the banking industry, growth of the secondary market, widespread adoption of automated underwriting, and the proliferation of thirdparty originators and brokers—and how these changes have affected the delivery of mortgage credit to lower-income families. They call attention to a bifurcation in the mortgage market, where lower-income families disproportionately receive mortgages from nonprime lenders. They worry that uninformed and choiceconstrained borrowers with good credit may inappropriately be put in high-cost mortgages or otherwise be subjected to abusive lending practices. Historically, community-based organizations (CBOs) have played an important role helping lower-income and other traditionally underserved borrowers to prepare for and negotiate the home purchase and refinancing process, and to avoid undesirable lending practices. However, many of the services provided by CBOs tend to be labor intensive, and their customers tend not to meet traditional underwriting standards, instead requiring specialized or individualized attention from lenders that partner with CBOs. As a consequence, CBOs increasingly find themselves squeezed by the individualized needs of their cus07 7409-5 pt02.qxd 7/7/2005 10:11 PM Page 104 tomers, and the lenders’ need for low-cost, standardized, or automated application processing. The authors worry that the aggressive tactics among some subprime lenders take business from CBOs. This reflects a version of Gresham’s law in...