Mortgage Bankers, Realtors Must Work Together to Prevent Default

Ask most low-to moderate-income people what keeps them from buying a home and they typically answer, "Coming up with a down payment."

But making a down payment is one thing; keeping up with monthly mortgage payments is another. A recent study found that up to 10 percent of affordable housing program homebuyers default on their mortgages. Clearly, these home buyers need more than upfront cash to open the doors to their new homes - and stay in them.

Mortgage bankers and real estate agents can and must do more to help struggling homebuyers. In many cases, we're required to help. But we also should be motivated because affordable housing constitutes a growing market that will help us achieve our mutual goal of enabling homeownership for as many people as possible. More importantly it's not good business to set customers up for failure.

Homebuyers who need lower down-payment requirements have access to a variety of programs. Fannie Mae's Community Homebuyer Program allows for lower down payments and expanded loan-to-value ratios. Freddie Mae's "Affordable Gold" program offers similar benefits. Banks fulfill their Community Reinvestment Act (CRA) lending requirements by participating in Fannie Mae's Middle Income Program, which allows borrowers to put as little as $1,000 of their own cash upfront into their home purchases.

While lower down-payment requirements have helped thousands of low-to-moderate income people achieve their dream of home ownership, some of these dreams have turned into nightmares.

Once in their homes, the owners fall behind on monthly payments, utilities and other expenses. The resulting defaults have led the mortgage industry and mortgage insurance companies to increasingly scrutinize loans with low down payments.

Mortgage insurance companies provide private mortgage insurance required on all conventional loans with loan-to-value ratios exceeding 80 percent - that is, loans made with small down payments of less than 20 percent of a home's value. These insurers want to understand how the loans perform to determine whether to continue covering them, and there's a real danger they could exit the market. The availability of private mortgage insurance in key to making homes affordable for lower income groups. Without it, banks, thrifts and mortgage companies could not risk providing them.

Mortgage Guaranty Insurance Corporation (MGIC), the nation's largest private mortgage insurer, analyzed loans made between 1992 and 1993 to determine the default rate. (MGIC recently updated that analysis to include 1994 business. While the numbers changed slightly, the results remained the same.) The findings are unsettling. MGIC examined four key factors that put low-to-moderate-income borrowers at risk for default. These factors include downpayment size, credit history, cash reserves after closing, and debt-to-income ratios. The ratios were defined by Fannie Mae and Freddie Mae "33/38" guidelines, which call for principal, interest, taxed and insurance (PITI) not to exceed 33 percent of gross income, and for PITI plus other debt not to exceed 38 percent of gross income.

According to the early results of the study, up to one in 10 affordable housing buyers may default. The more risk factors a borrower hand, the higher the default risk - up to an astounding seven times greater risk

If a borrower's down payment was 3 percent rather than 5 percent, the default rate was doubled.
If a borrower had a recent history of late payments, the default rate was four times higher than for borrowers with excellent credit.
If a borrower did not have a traditional credit history, the default rate was eight times greater than for borrowers with excellent credit.
If a borrower exceeded the 33/38 income guidelines, the default rate for borrowers who were within the guidelines.
If a borrower had fewer than two month's cash reserves after closing to cover PITI, the default rate was 40 percent higher than for borrowers with two or more months of reserves.

Too many lenders and real estate agents focus on the short term transaction - getting this client into a home, whether he or she is ready for the responsibility or not. But it does no good to the homebuyer who suffers the indignity of foreclosure a few months or a year later. To be successful, the industry must balance opportunity for homeownership with the potential for sustaining homeownership.

Economic trends indicate that demand for programs which help low-to-moderate-income buyers will continue to grow. The market always has had buyers who lack the money they need or fail to quality for the homes they want. This segment is growing. Rising rents are depressing potential buyer's abilities to save for down payments. Renters and homebuyers are paying an increasingly large proportion of their disposable income toward housing expenses. Furthermore, the ongoing displacement of manufacturing jobs with lower-paying service jobs will continue to hold down personal income.

All these factors stress the need for mortgage bankers and real estate agents to work together to preserve existing affordable housing programs. Yes, Fannie Mae has committed to making affordable mortgages comprise 30 percent of its new loans, and clearly plans to be proactive in that market. But Fannie Mae can't do it alone. We must find additional ways to help people on the path to homeownership We must bear in mind the fact that we are not saying "no" to homeownership. We are saying "not yet".

Gordon Steinback, MGIC's executive vice president for Affordable Housing, stated in his June 1995 article for Mortgage Banking magazine that it appears that the mortgage finance industry is establishing a "new paradigm for doing affordable housing business. If the industry wants to expand opportunities for home ownership to low and moderate income buyers, it should (it seems) simply lower underwriting standards applied to those loans. And if lower down payments and expanded debt-to-income ratios do not produce the volume we need, then we lower the standards again".

By lowering standards as a way to increase volume it is clear that we are increasing the default rate. The trauma of foreclosure far outweighs the frustration of not being able to qualify for a mortgage. Allowing 1 in 10 affordable housing buyers to lose a home to foreclosure is unacceptable. It's bad for the client and it's bad for our business. Borrowers who suffer foreclosure are unlikely to refer their friends and relatives to an agent and unlikely to ever "move up" as a buyer. They may never refinance or apply for a home equity loan. A 10% default rate could result in mortgage insurance companies unwillingness to provide coverage. If so, mortgage lenders won't make these loans, and real estate agents won't earn the commissions on selling those homes.

Competition - due to overcapacity in the mortgage banking industry, the need to comply with CRA requirements and the Home Mortgage Disclosure Act - could have disastrous consequences for the industry. All these factors apply pressure to approve increasingly risky loans to lower-income homebuyers. Few agents or mortgage lenders would intentionally do anything to imperil their ongoing source of income. Yet short term, deal by deal thinking will result in the demise of some affordable housing programs. Since affordable housing programs are going to be the lifeblood of our industry, to imperil them is short-term thinking at its worst. It is akin to skinning the goose that laid the golden egg. Instead we need to think more strategically about how to mitigate the risks of foreclosure.

Nontraditional clients require nontraditional methods of mortgage lending. Lenders and agents must help homebuyers through education and counseling long before any purchase agreement is signed - especially when dealing with first-time homebuyers.

The marketplace includes homebuyers with varying degrees of need, both in terms of their financial resources and understanding. Most agents already ask prospects some questions before taking them out to look at available properties. They often require preapproval or a "looks good" letter from a loan officer before writing a purchase agreement. However, these steps still don't differentiate homebuyers who can sustain homeownership from those who can't. The latter group, in particular, needs and welcomes education and counseling about the financial commitment they're about to make.

Homebuyer education might mean a class, book, video or one-one-one-session with a loan officer. It should cover the ABC's of the home buying process, including the financial obligations that come with home ownership. Prepurchase education helps the prospective buyer answer the question: "Is homeownership for me?" Such education should start earlier in the homebuying process. Otherwise, buyers make emotional commitments to their new homes, and they'll then to view the education process as just one more hoop to hump through before the lender will close the loan. Timely and effective pre-purchase education could be a powerful offset to the inherent risk in affordable housing lending - we need to make it a priority.

Education may be enough for some homebuyers, but others require more hand-holding. Counseling is a more intensive process in which a professional and client define realist and sustainable goals, and formulate a home ownership plan. Counseling may include credit review and improvement, budgeting and saving for a down payment, paying off debt or getting into a more stable income situation. It is a commitment which can take from 6 months to several years. We can think of clients in counseling as our "pipeline" of future buyers. We shouldn't try to force them into homes with expanded underwriting guidelines before they are ready to assume that responsibility. Instead, we should expends the time, effort and energy necessary to improve their likelihood of success. We can help them learn and practice budgeting techniques and good credit habits. Homebuyer counseling should include post-purchase support services to help prevent foreclosures by use of early intervention programs.

Counseling typically is provided by nonprofit social service agencies. A list of available home buyer education and financial counseling services, as well at the information about affordable homeownership and rehab programs, may be obtained by calling The Minnesota Housing Finance Agency and asking for the Affordable Housing Home-ownership Directory at 621/934-7325. The directory is a joint effort of the MHFA and the Mortgage Bankers Association of Minnesota (See Minnesota REALTOR®, Fall 1995, P,. 14).

It's time for mortgage bankers and real estates agents to work together Understanding the issues and developing an agenda for the future are strong first steps.