Many renters, facing rising housing costs, feel stuck. They would love to buy a modest home. They’d love a modest loan to go with it. But…
Try finding a mortgage to buy a home under $150,000 these days.
Where small mortgages are available, the people who want them get turned down more often than people who seek larger loans — even when these loan applicants have similar credit profiles.
So the people looking for homes in “economy class” turn to alternative financing modes. Some go into co-ownership with their friends. Some buy homes from family. Others do whatever it takes to come up with cash. Or they just let go of their hopes.
What makes such a simple quest such a challenge?
High Cost to Lenders: Ripples From the Great Recession
Before the recession in the early 2000s, it was not such a big deal to get a small mortgage.
But after that time, some lenders stopped offering these options. Homes got more expensive, so loans got bigger. But is that the real issue? Or is it that lenders just don’t profit from small mortgage loans?
It’s become very expensive to originate loans. Banks must comply with the federal government’s lending regulations enacted in the wake of the recession.
Strict regulations do make the mortgage lending industry safer. But they also weigh lenders down with heavy rules, meant to ensure their borrowers’ capacity to repay what they borrow. (The rules have been relaxed slightly, but compliance costs are still burdensome.)
So, yes: the cost of small mortgage lending is harder to justify for lenders. Some mortgage providers have set loan minimums that push more and more buyers into all-cash purchases.
Older Homes Can Be Cheaper—But Also Harder to Insure
Lenders are also concerned about their collateral — the homes they finance. Homes that cost below $150K tend to be older homes, with older systems. Choosing a home that could have physical issues? It could be cheap to buy — but hard to finance. A federally backed loan becomes impossible to get when a home’s condition can’t meet stringent federal standards.
If a home has updated electrical, HVAC, and plumbing systems, potential buyers are more likely to get approved for financing. This allows them to buy now, and renovate later. Some manage to buy old houses with cash, then apply for rehabilitation loans.
☛ Given the high price tags on existing homes today, buyers might consider fixer-uppers or even teardowns. Does this make financial sense? See: It’s Complicated: A Six-Step Plan to Buying a Teardown.
Alternatives to Mortgages: Missing Safety Features?
When mortgages are off-limits, what options do people use? Many buyers of low-cost houses feel they have no choice but to get creative with financing. they could look to small banks with their own underwriting systems. Or they might seek safe options with their state government housing authorities.
They might seek out higher-interest personal loans for manufactured homes. Maybe they’ll sign installment agreements with their sellers. Some of these buyers are taking extra financial risks. They miss the safeguards of a regular mortgage.
Buying with a mortgage…
- Means the bank has actually appraised the property for the seller’s price.
- Comes with an inspection process to verify that homes meet habitability baselines.
- Has consumer-protection features to help prevent foreclosures.
- Includes standard deed transfer processes. This ensures that buyers can prove their ownership status.
Fixed-rate mortgages also help home buyers cope with inflation, as they create set payment schedules throughout the course of the loan.
Painful for Many, But Minority Communities Suffer Most
According to The Pew Charitable Trusts, low-cost homes are still out there, and people do buy them. But of all the homes that sell for under $150,000, only a quarter of them were bought with a mortgage.
That is a very small percentage. About three-fourths of home buyers in general take out mortgages. Most people aren’t in the position to buy homes in any other way. Nearly all first-time buyers need mortgages. If they can’t get their mortgages, they’ve lost out on the chance to build equity.
As you might assume by now, the scarcity of small mortgages hits minority communities and rural people hard. It’s a setback for anyone who simply cannot come up with ready cash. Households with an income level of less than $50K are much more likely to turn to alternative financing to get homes. Seven times more likely. And more than a third of Latinx borrowers use some kind of nonstandard financing.
On top of it all, there’s the pain of trying to buy a home in markets wherever investors are buying homes with cash and then flipping them into the rental market.
Some corporations see frustrated buyers as an opportunity, and they offer a service of paying cash up front for their customers. These customers might become successful buyers — but they pay more for the service that helps them do it.
Light Beyond the Tunnel?
In 2022, Fannie Mae and Freddie Mac, under the direction of the Federal Housing Finance Agency, ended guarantee fees to lenders working with certain lower-income mortgage applicants. This brought down the cost of financing modest homes. And the agency’s move to promote desktop appraisals is also cutting costs on many loans. (As defined by the National Association of Realtors®, a desktop appraisal is fully remote. The desktop appraisal report uses listing details and data from public sources, like tax records.)
Additionally, Fannie Mae and Freddie Mac have started allowing rental payment history to count in approval determinations. Freddie Mac has expanded the types of income it counts, too. These changes are supportive of first-timers and loan applicants with modest incomes.
The new breed of fintech (financial technology) that integrates machine learning could also help more buyers safely qualify for mortgages.
☛ Is the FICO Score Obsolete? Learn about the quest for inclusivity and fairness through artificial intelligence (AI).
Still, Policy Changes Are Needed
No logical person wants banks to get blasé about mortgage lending. That would tend to lead to defaults later. But has the pendulum swung too far in the direction of strict rules and high compliance costs? Throughout the United States, there’s clearly a pressing need for loans for lower-priced homes.
At the end of the day, our government needs to support home buying, not repel people from it. Underwriting rules need to allow access to safe, equity-protective mortgages.
Supporting References
Tara Roche for The Pew Charitable Trusts, via PewTrusts.org: Financing a Low Cost Home Should Be Easier (Mar. 28, 2023).
Alex Horowitz for The Pew Charitable Trusts, via PewTrusts.org: What Has Research Shown About Alternative Home Financing in the U.S.? (Apr. 4, 2022; updated May 31, 2022).
Alex Horowitz and Tara Roche for The Pew Charitable Trusts, via PewTrusts.org: Issue Brief – Small Mortgages Are Too Hard to Get (Jun. 22, 2023).
Aarthi Swaminathan via Realtor.com® / MarketWatch: Bad News for Aspiring Home Buyers: One Type of Mortgage Is Becoming Increasingly Rare By (Jun. 23, 2023).
And as linked. Cited within the above resources are data from the Consumer Financial Protection Bureau, National Archives, U.S. Census Bureau, the Zillow®Group Transaction and Assessment Database, and other sources.
Photo credits: Marta Wave and Ivan Samkov, via Pexels.