#168 Winter 2011-12 — Capital Markets

Relaxing the Credit Crunch

Three years after the financial meltdown, credit remains elusive in many underserved communities. Although the reliance on credit scores is greater now than it’s been in a decade, many housing activists and community lenders are arguing for other means to evaluate credit risk.

Courtesy of Cal≠ifornia Reinvestment Coalition

Adam Rust (far left), of Community Reinvestment Association of North Carolina, with three high school students who testified against the Capital One/ING merger.

Before Ginger Hitzke was the president of her own Hitzke Development Company, she was frustrated in her efforts to get mortgage credit. Not because her credit history was bad, but because her financial history didn’t necessarily lend itself to a traditional credit history. “When I was a younger person trying to get a loan for the first time,” she says, “I spent money on things like utilities, rent, food, and the babysitter — things that don’t get reflected in a credit score.” By the time she had a credit history developed enough to qualify for lending programs that target underserved communities, her income had grown to the point where she was no longer considered part of that community.

If Hitzke struggled just from being young, imagine how much harder it would be for someone whose credit record is blemished by a foreclosure, medical debt, or job loss, and who might live in an area or belong to a demographic that already experiences credit discrimination. And yet, with the backlash to the housing crisis among lenders, and the effects of that crisis and rising unemployment on households’ finances, mortgage credit is becoming harder and harder to get just when neighborhoods desperately need new homeowners to step in and fill up their vacant properties.

As the mortgage industry tries to recover from the housing crash and deal with piles of toxic debts on its books, the more stringent lending practices of the 1980s have been returning with a vengeance, including for many lenders less leeway on credit score minimums. This means that even with mortgage interest rates at historic lows and with the federal government playing lip service to the notion that banks should get lending again, credit seems to be elusive to those with working-class incomes. How can lenders — and affordable housing advocates — support sound underwriting practices while also trying to keep appropriate amounts of credit flowing to underserved communities?

How Did We Get Here?

Buying your own home — a fixture of the American Dream — was once seen as the hallmark of stability and maturity. Double-digit interest rates enforced the idea that buying a home wasn’t something to be taken lightly. In the early ’80s, loan programs beyond conventional fixed rates and government loans were few and far between, according to Mary Townley, director of homeownership for the Michigan State Housing Development Authority: “Underwriting criteria was tough and most companies required a hefty down payment of 10 to 20 percent.”

Under both the Clinton and Bush administrations, HUD, Fannie Mae, and Freddie Mac all aggressively pushed an expanded vision of homeownership through tax credits and other programs. “In the ’90s guidelines adjusted and more and more programs rolled out into the market. These programs were created to provide options to homeowners since all of their situations were not the same,” Townley says.

But it wasn’t necessarily the push to expand homeownership that caused the housing crisis. John Taylor, head of the National Community Reinvestment Coalition, (NCRC), argues that it was reckless, predatory lending practices and lack of regulation — not programs designed to helped lower-income homebuyers. “Nine out of 10 of the subprime loans had nothing to do with new homeowners,” he says. “They were refinancing or moving homeowners into bigger homes. I was there. I saw what Fannie and Freddie were doing. There were lenders that were making everyone rich at the expense of the homeowner and the investor. They squeezed the homeowner for everything they could.”

Back to the Future?

However it happened, as banks were closed during the Great Recession or merged with other larger institutions, the remaining lenders became much more conservative, inflicting tougher standards that “at times are taking us back to the ’80s,” Townley says.

Clark Ziegler, executive director of the Massachusetts Housing Partnership, (MHP), says that in addition to seeking a sobriety of lending that should have existed during the bubble, some of the new conservatism stems from Fannie and Freddie, which are “aggressively trying to minimize their losses, so every time a loan defaults they are scouring the paperwork to see if the originating lending made any errors. If there’s a breach of ‘representations and warranties’ then the original lender can be forced to buy the loan back, even though Fannie/Freddie was paid a fee to guarantee the loan . . . As a result lenders say they are forced to micro-manage the loan process to avoid even the slightest errors.”

The Score

Credit scores, as a hard number rather than a complex underwriting judgment call, are presumably seen as easier to defend to the secondary market. But they are a mixed bag to those concerned with affordable homeownership and fair lending.

A Shelterforce ad seeking donations from readers. On the left there's a photo of a person wearing a red shirt that reads "Because the Rent Can't Wait."

Many in the industry use them and find them useful. “We instituted minimum credit scores about six or eight years ago,” says Ziegler, as he describes his organization’s SoftSecond program (see p 37). “We’ve analyzed the loans since then and the credit scores are a good predictor of loan performance.” On the other hand, “You don’t want to exclude people that might be good borrowers,” Ziegler says, adding that the biggest challenge is assessing potential borrowers with alternative credit or not enough history. “Savers that have lived without credit but make timely rent payments, make timely utility payments. Those are the folks that we created the program to serve.”

Some of the issue, Ziegler says, is consistency. “You want standards that you apply fairly from person to person but at the same time, there’s got to be a way for responsible folks with bad credit history to work their way back into good graces. It’s very hard. It puts you in the position of judging how good an actor someone was. There’s not an unlimited number of folks who have worked hard, saved money, cleaned up their credit.”

“Credit scores are a critical tool in the mortgage industry,” Townley says. “They are a tool and we do not use them solely for approval of loans. Our office does look at scores, but in certain incidences we look at other factors for loan approval. Our goal is to determine the buyer’s willingness and ability to make their monthly mortgage payments. An analysis of their current rental history, other credit payment history, alternative credit verification (telephone, cable, and electric), savings pattern, ratios, and residual assets help us look at the ‘big picture.’”

“We use the credit report to analyze the loan but we have no minimum credit score and no risk-based pricing,” says Spencer Scarboro, senior vice president of loan originations for the State Employees’ Credit Union, in Raleigh, N.C. He describes a process that relies less on automation and more on a holistic approach to underwriting that considers factors such as a loss of a job or a death in the family that may have contributed to a less than glittering credit score. “You have to look at the total picture,” Scarboro says. “It’s our job to find out why they had credit issues.”

“The best investment that we can make is in our members,” Scarboro says, citing a 60-day delinquency rate in his organization’s portfolio of less than 2 percent and a charge-off rate that is one-quarter of 1 percent, which is “well below our peers.”

One advantage Scarboro says he has is that his credit union does not sell its loans to the secondary market, eliminating what he considers to be excessive documentation requirements and providing his institution with more flexibility in its lending.

Policy Changes Needed

Not every lender can hold all its loans in a portfolio. And so, Josh Zinner, co-director of the Neighborhood Economic Development Advocacy Project, (NEDAP) in New York City, says the government must play a strong role in the secondary market to ensure that its requirements and the lenders who sell to it do not freeze out lower-income communities and communities of color through inflexible credit score requirements.

For Zinner, banking is akin to a public utility, particularly for the “too-big-to-fail” banks. Because the Federal Reserve took such a prominent role in supporting big banks during the 2008 financial crisis, those institutions have an obligation to their communities, he argues. “Banks need to be held accountable,” Zinner says. “They’re heavily subsidized by taxpayers in numerous ways that give them a huge competitive advantage. They have an absolute obligation to serve communities equitably and to do mortgage lending in communities of color.”

Zinner argues that bank discrimination makes credit more expensive in communities of color, creating a vicious circle in which over-priced credit causes consumers to fall behind on their other obligations, leading to weakened credit scores and even more expensive credit. He considers credit scores and credit reports to “reflect and amplify discrimination. You can have bad credit because of where you live.”

“We need to affect the policy surrounding credit,” says NCRC’s John Taylor. “We can’t make the mistake we always make that we will provide the solution. We’ll create a product, a program, a pilot, but all we’ll do is create a piecemeal solution.”

Taylor focuses his energy on the big banks that, he says, have ample resources and capacity to expand their mortgage loan portfolios in underserved communities, but require community pressure and federal regulation in order to do so. He cites the Federal Reserve, the court system, class action lawsuits, fighting mergers like that of Capital One and ING, and the media as among the tools and strategies citizens and advocacy groups need to leverage to force big banks to step up their lending. “By any means necessary to influence the private sector to step up,” he says.

“We have to end business as usual where these too-big-to-fail banks don’t make a commitment to underserved communities,” says Taylor. “They can’t just launch one high profile program once in a while. Serving these communities needs to be part of their business plan. If these banks want access to the Federal Reserve’s window, they need to be present in these neighborhoods.”


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