Housing in the Rust Belt: Homes Too Affordable to Finance
When Jada and I first came to South Bend as part of the Invanti generator, we had the opportunity to meet many different people working across South Bend. By Jada’s tally, we met over 100 people in our first week. Our goal was to learn the problems they saw people in the community faced with existing financial services. The problem we heard most frequently was something neither of us had come across before: prospective homebuyers could not get mortgages for houses worth around $70,000 or less. With most of the national discussion about housing being too expensive, it was surprising to learn about a problem with housing being too affordable.
Are there even houses in that price range?
Jada is originally from LA and I grew up outside of Chicago, so we had that same initial question: you can buy a house for less than $70,000? Yes, yes you can. In fact, houses in this price range make up a significant amount of the stock in smaller cities. One study found that of the 12% of the housing in South Bend that is priced at $50,000 or less, approximately 5,600 units. Another surprise for us was the quality of the houses. Sure, some would need a lot of work, but many are move-in ready with 2–3 bedrooms, begging for a homeowner to come in and make a life there.
But are there people who would want to own these houses?
The answer again is yes. Homeownership is still an integral part of most people’s American Dream, especially for people who would be first generation homeowners. Many of these houses can be great opportunities for prospective buyers whose other options are to rent (without building equity and dealing with the instability) or buy through seller-financing (often predatory with few legal protections). Renting is a good option for some to be sure, but it does not contribute to someone’s wealth overall. We have heard about many people who are interested in houses in this range, and the number of rent-to-own and land contracts happening (despite their negative attributes and potential risk) further speaks of the significant demand.
So what’s the problem?
So there are houses and there are interested buyers — the next step is normally to get a mortgage to put the two together. But as we mentioned at the beginning, that does not seem to be an option on this side of the market. When we asked why, we were told a host of different reasons. Some people said it was that there are no potential buyers who can qualify for financing. With bank lending qualifications being at a high since 2001, this sounds reasonable. But we met with a number of people who have high enough incomes, credit scores, and savings, but still cannot get a loan, and we heard about many more. Other people gave the explanation that there are no livable houses in this range. Again, it sounded reasonable but did not bear up when looking at available evidence. We have seen many houses in this range that are in good shape and ready for sale. Others said banks are willing to make these loans, but no one ever asks. Yet we heard from some would-be homebuyers saying they had tried multiple banks to no avail. Even looking at the number of houses (5,600) compared to how many are under mortgages (~60, or about 1%), this seems like it cannot be the complete answer either.
While the low mortgage rate is likely a combination of these and other factors, the explanations that made the most sense to us actually have to do with the banks. The first is about how banks usually make money off of mortgages. When a bank lends to a homebuyer, they charge a suite of fees including for underwriting, and origination, usually as 1–2% of the full loan amount. This covers their time working on the loan, from the loan officer meeting with the buyers to the underwriter determining whether the loan should be made. After the loan is made, the bank often sells it on the secondary market, usually to Freddie Mac or Fannie Mae. They will get back the money they lent so they can make new loans (increasing the liquidity of the market), while keeping the fees they charged and handling the servicing (collecting) for the loan, for which they earn a fee, typically a fraction of the interest being charged. Many banks have a portfolio of loans they do not sell, but pretty much all of them will sell a share of those they make, the frequency varying according to the bank. So in this system, banks’ revenues are coming as a percentage of the loan despite most of their costs being fixed (it generally takes the same amount of time/work to make a $30,000 mortgages as it does to make a $300,000 loan). It makes sense they are not leaping to make these mortgages. Add onto this the Home Ownership and Equity Protection Act (enacted in 1994, updated in 2013). HOEPA caps the closing costs for a mortgage at 5% of the loan amount. This includes an appraisal ($250–500), title checks and insurance ($900–1,500), among other costs in addition to the banks’ fees, quickly hitting that 5% cap for a $30,000 mortgage. The non-bank costs are set by independent operations — it’s unlikely a bank could convince an appraiser to give a discounted rate on one of those properties so that all parties cover their costs, which means banks often make a loss on a loan of this amount. It is hard to fault the banks for being less than excited to make one of these loans (there are other, less forgivable reasons banks may not lend in this market, but we will hold off on those for now).
So what is a buyer to do? Previously their options were to rent (building no equity), try to find seller-financing (rarer and riskier than is ideal), or look for a bank or a broker who is willing to make the loan (some will, but few advertise it). Now though, we at Hurry Home are working to provide an alternative option, a pathway to homeownership that aligns our company’s goals, our investors’ goals, and our homebuyers’ goals -> the only way any party succeeds or profits is if the homebuyer succeeds and owns the house outright at the end of the transaction. We will share more about how and why we are doing this in additional posts. Stay tuned!