What if housing policy included a “public option” for low-income homeownership? Rather than seeking a mortgage from a private lender, qualified potential buyers could borrow from and repay to a federal agency or a nonprofit.
Some such options already exist. One that has been around for 70 years and is successful but little known is the U.S. Department of Agriculture’s direct loan program for low-income rural homeownership. In the USDA Section 502 direct loan program (named after Section 502 in the Housing Act of 1949, as amended), USDA is itself the mortgage lender. It is kind of a public option for mortgage lending (to borrow a phrase from the health policy world). USDA is also the direct lender for a home repair loan and grant program for very-low-income rural homeowners, Section 504.
The approach of USDA being the direct lender differentiates the 502 direct loan program from the mortgages offered through HUD’s Federal Housing Administration and the Department of Veterans Affairs. In those programs, private lenders make the loans and the federal government insures them, or backs them up with a guarantee.
While the USDA also has a similar program of mortgage guarantees, confusingly also under Section 502, it serves a substantially higher income level than Section 502 direct loans (and is much bigger than the direct loan program). The average income for a Section 502 direct borrower was $35,220 in FY 2019, compared to $63,240 for the Section 502 guaranteed loan program. One of the biggest differences between the programs is that the direct loans are eligible for a payment assistance subsidy while the guaranteed loans are not.
The Section 502 direct program for low-income homeownership is unique in federal housing policy. The program began in the 1950s as support for farmers’ homes and later expanded to all rural residents. The USDA self-help housing program also uses 502 mortgages. They have a term of 33 years, are not available with risky adjustable rates, have a 100 percent LTV (loan-to-value ratio, i.e., they don’t require downpayments), and have procedures in place to help borrowers who hit financial trouble. One might say that Section 502 direct loans are subprime lending done right, without punitively high interest rates or other provisions that make it harder for borrowers to succeed. As with any lending program, there are some delinquencies and defaults, and these are included in the overall cost of the program.
All loans must go to low-income borrowers making 80 percent of area median income (AMI) or below and 40 percent of the total loan dollars must go to very low-income borrowers making 50 percent of AMI or below. (The U.S. median income in 2019 for a four-person family in nonmetropolitan areas, as determined by HUD, was $60,600. Eighty percent of this figure is $48,480, and 50 percent is $30,300.)
The program offers an interest subsidy for the vast majority of borrowers who cannot afford to repay the loan at the full interest rate, which is how it can reach the very-low-income borrowers. Eligible borrowers must be unable to secure the necessary credit from other sources on terms and conditions that they could reasonably be expected to fulfill.
They do have to be able to show an ability to repay the loan—ratios of no more than 29 percent PITI (principal, interest, taxes, insurance) to income and 41 percent total debt to income. There are no firm credit score requirements to meet—applicants with credit scores of 640 or higher do not require further credit analysis, but generally no one is rejected based on credit score alone. About 50 percent of the home’s appreciation, or the amount of subsidy received, whichever is less, may be recaptured by the government if a borrower sells or ceases to occupy a home.
The program also has several loan-servicing features designed to keep borrowers in their homes when they encounter circumstances that make it difficult for them to meet the terms and conditions of the loan. The agency is required to provide regular follow-up and counseling for delinquent loan accounts. USDA may enter into a “delinquency workout agreement,” where the borrower agrees to make the required monthly payment plus an amount to bring the account current over time. For borrowers who suffer a loss of income, the agency may review their eligibility for new or additional payment assistance. Borrowers experiencing temporary financial difficulties for reasons beyond their control may be eligible for a payment moratorium, a temporary cessation of payments to help them recover from a loss of income or unexpected expenses. The payments can be made up through a workout agreement, or the loan may be reamortized if needed. Sometimes accrued interest is forgiven if necessary.
Since it launched in 1950, the Section 502 direct loan program has made $75.5 billion in loans on nearly 2.2 million homes. Very few of these low-income families would have become homeowners without this program. Section 502 supported over 100,000 purchases a year in the 1970s, but by 2019 that number was down to 6,200. Between 2011 and 2019 about 37 percent of 502 direct loans went to households of color. People of color made up 33 percent of rural and small-town residents in the 2010 census.
For fiscal years 2017 through 2020, Congress has authorized a program level of about $1 billion in loans a year for the 502 direct loan program. The actual appropriation amount has averaged $67 million a year. These amounts are called “budget authority” and are based on the present value of the cash flow generated by repayment, including any losses. Based on the average loan of about $151,000, the per-loan cost to the taxpayer is around $10,000. This is the cost for the life of the loan, not on an annual basis.
This program is one of many government programs competing for limited funds amid pressures for a balanced budget. Though the program has strong bipartisan Congressional support, most secretaries of agriculture have not been fans, seeing it as competition for other USDA programs. Since the 1980s, the program’s funding has steadily declined, while the cost of housing has increased, significantly reducing the number of loans it can make. Each of the Trump administration’s budget proposals have included zero funding for the program, and the Obama USDA budgets proposed to cut it by 70 to 80 percent in fiscal years 2012 to 2015. Congress, on a very bipartisan basis, rejected all those cuts, but the program is still much diminished from its peak.
The Housing Act of 1949 also created the USDA Section 504 program for the rehabilitation and repair of homes owned and occupied by very low-income rural households. This program makes both loans and grants, again directly from and repaid to USDA. The grants are only for very low-income elderly. The Section 504 program from 1950 through 2018 made 198,107 loans totaling $911.8 million and 216,286 grants totaling $1.039 billion. The Trump administration’s budgets have all proposed to zero out this small program, but again Congress has said no.
An interesting and often forgotten fact is that HUD once had a similar low-income homeownership program, Section 235, though with a crucial difference—it subsidized loans made by private-sector lenders rather than lending directly. HUD insured the lenders against loan losses and provided the interest subsidy. Section 235 experienced some scandals involving builders, speculators, lenders, and a few FHA employees who, in the words of Zane Curtis-Olsen, “took advantage of the loopholes and lack of oversight in the programs to cycle collapsing homes through the hands of poor families while skimming money from the federal government.” It was suspended after six years. Without the subsidies for the private market, however, there would have been far less opportunity and incentive for that kind of skimming. What if it had instead been structured like the 502 program, with underwriting and risk management conducted in-house?
Low-income homeownership plummeted and the racial homeownership gap expanded after the 2008 foreclosure crisis. There’s a clear need for a public option for mortgage financing. The 502 direct program ought to not only be preserved and expanded, but should be used as a model for programs that serve the whole country.