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

Chapter 7. Hitting the Wall: Credit as an Impediment to Homeownership

Representing the American Dream, homeownership has long held a special place in the United States. A significant fraction of the typical American household’s wealth is wrapped up in its primary residence, which makes homeownership a vital investment tool (Kennickell, Starr-McCluer, and Surette, 2000). Moreover, homeownership has been found to have ancillary benefits, such as better health outcomes for members of a homeowner’s family and a lower incidence of neighborhood challenges such as crime and blight (Aaronson , 2000; DiPasquale and Glaeser, 1999; Rohe, McCarthy, and van Zandt, 2000; Haurin, Dietz, and Weinberg, 2002). These perceived benefits have been the motivation for the many homeownership incentives extended by all levels of government, including the mortgage interest deduction for federal income tax calculations and the Bush administration’s American Dream Down Payment Initiative, whose goal is to dramatically increase homeownership rates among lower-income households. Given the important role that homeownership plays for households and communities, overcoming barriers to homeownership is an important social and public policy goal. This is especially true in the case of minority and lowerincome communities, many of which have struggled to build and maintain the wealth and stability that homeownership has been shown to confer. Identifying how changing credit quality—poor credit quality being one of the major financial barriers to homeownership that households must overcome (Rosenthal, 155 Hitting the Wall: Credit as an Impediment to Homeownership raphael w. bostic, paul s. calem, and susan m. wachter 7 11 7409-5 ch07.qxd 7/7/2005 10:13 PM Page 155 2002; Barakova and others, 2003)—may be affecting access to homeownership across demographic groups is a key step to informing policies to overcome these barriers. Important changes in consumer credit markets occurred between 1989 and 2001, including expanded access to bank revolving credit, the emergence of a subprime market, larger debt burdens among some segments of the population , and increased bankruptcy rates. These changes all have implications for the distribution of credit quality across the population. This chapter examines how credit quality has evolved during this period. The focus is on the incidence of poor credit quality, with an eye toward identifying those segments of the population that have seen significant improvements or setbacks over the past decade. The results of the analysis are considered in the context of homeownership and the success of policy initiatives designed to increase the homeownership rate. Given areas of current policy focus, a central issue is the experience of minority and lower-income individuals and their prospects looking forward. Background Many researchers have studied the extent to which households have been unable to become homeowners due to borrowing constraints, which include income, wealth, and credit quality limitations. Most of this work has centered on the importance of income and wealth constraints and has found that insufficient wealth is the biggest barrier for households contemplating homeownership (Rosenthal, 2002; Stiglitz and Weiss, 1981; Linneman and Wachter, 1989; Zorn, 1989; Haurin, Hendershott, and Wachter, 1997; Quercia, McCarthy, and Wachter, 2003). Two additional recent studies explicitly quantify the importance of poor credit quality as a barrier to homeownership, and provide evidence that credit quality is becoming an increasingly important barrier to homeownership. Rosenthal (2002) finds that credit quality is indeed a barrier to homeownership for households, as bankruptcy and a history of delinquent loan repayment are positively related to the likelihood of being credit constrained but unrelated to the probability of wanting to own a home. The key finding is that the removal of credit constraints, as defined by Rosenthal, would increase the homeownership rate by about 4 percentage points (or about 6 percent). Barakova and others (2003), like Rosenthal (2002), incorporates credit quality into the analysis of terminal outcomes. But, in addition, this research distinguishes among the effects of constraints based on income, wealth, and credit, and tracks how the impact of each type of constraint has evolved during the 1990s. Barakova and others find that in 1998 the homeownership rate among recent movers would increase by 10 percent if those households with poor credit quality 156 keeping score 11 7409-5 ch07.qxd 7/7/2005 10:13 PM Page 156 had had unblemished credit records.1 This compares to a 6 percent increase for a comparable thought experiment in 1989. Thus for this population, the importance of credit quality constraints nearly doubled during the 1990s, reflecting an increase in the proportion of households with poor credit quality...