Loan Guarantees Are Not Enough

It’s less expensive for the government to guarantee a loan made by a bank than to be the lender itself. FHA and VA loan guarantees are well known and well used. It’s not surprising, then, that there has been a shift in USDA’s lending too, away from direct loans towards guarantees, especially after recent changes made USDA’s guarantee programs self-supporting. But guarantees cannot replace direct loans—they serve different populations.

USDA’s Rural Development arm administers direct loan programs for homeownership and for development of rental housing, and loan guarantee programs for the same two purposes. (The program names are confusing: the homeownership programs are Section 502 direct and Section 502 guaranteed, while the rental programs are Section 515 direct and Section 538 guaranteed.)

In the last couple of years, fees for both guarantee programs have been set at levels that make the programs “revenue neutral.” The loans’ origination fees and annual fees generate enough revenue to cover any payouts needed. The government does still bear the cost of salaries and expenses to run the programs.

Although the guarantee programs cost the government very little, they cost borrowers more than loans made directly by USDA. Interest rates on guaranteed loans are set by the for-profit lenders who make the loans. Interest rates on loans made by USDA, on the other hand, are subsidized and can be as low as 1 percent. (All Section 515 loans are subsidized to a 1 percent interest rate; the subsidy for Section 502 direct loans varies, depending on the homebuyer’s income, and can take the interest rate to as low as 1 percent.)

Not surprisingly, then, there are substantial differences in the income levels of borrowers served by the programs for both homeowners and renters. In 2011, homeowners receiving Section 502 direct loans had an average income of $27,053, compared to $50,571 for owners with Section 502 guaranteed loans.

Similarly, the average income of tenants in developments financed with Section 515 direct loans was $11,142 as of May 2011. No comparable figure is available for tenants in properties with private loans guaranteed under USDA’s Section 538 program, but in 2005 the administrator of USDA’s housing programs told Congress the average income of tenants in Section 538 developments was $18,400. That was more than $10,000 higher than the $8,158 average income for tenants in Section 515 properties at that time.

Do these loans perform well? To qualify for USDA’s direct mortgage program, families must have low incomes and to qualify for the guarantee program, they must have low or moderate incomes. Yet USDA’s delinquency and foreclosure rates are comparable to those of other lenders and guarantors. The Wall Street Journal reported last spring that 12 percent of USDA’s guaranteed homeownership loans and 17 percent of its direct loans were delinquent or in foreclosure.

In other words, 88 percent of the guaranteed loans and 83 percent of the direct loans were in good standing. It is not surprising that some of USDA’s borrowers have been affected by the recession. It may be more surprising that a far greater proportion are successful homeowners, despite their income levels.

Those 88 percent and 83 percent rates represent more than half a million homeowners with USDA guarantees and more than 230,000 with USDA direct loans, in addition to the one million or so who have already paid off their USDA mortgages. All those borrowers turned to USDA because they could not receive standard loans from the private market, and succeeded as homeowners despite their low incomes.

Demand for both USDA guarantee programs is high; clearly they are meeting a need. But they cannot meet the same need as the direct loan programs. Section 502 direct homeownership loans are particularly important as safe, fixed-rate mortgages for very low- and low-income rural Americans who cannot qualify for private mortgages, ensuring that they will not turn to predatory lenders to achieve their dreams. Section 515 rental housing loans are essential to produce and preserve affordable units for the lowest income rural residents, who face a significant shortage of low-rent units nationwide.

All four programs, both direct and guaranteed, must be maintained.

Note: Recently The Wall Street Journal and CBS News ran stories criticizing USDA’s handling of foreclosures in the Section 502 guarantee program. The Housing Assistance Council recognizes those problems but, as HAC wrote in a letter to the editor published in the Wall Street Journal, “The debt collection practices described in the article should be corrected, but this does not mean—as some of the online commenters suggest—that USDA should be taken out of the mortgage business. . . . While we find ways to improve USDA’s treatment of its borrowers facing defaults and foreclosures, we should also celebrate its successes and embrace its future.”

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