Wealth Building Home Loans are fixed-rate, 15-year loans that build equity much faster than a 30-year mortgage.
By William M. Isaac and Edward Pinto
Sales of existing homes in August were down 5.3% year-over-year. The housing lobby says credit is too tight. The commissioner of the Federal Housing Administration and the director of the Federal Housing Finance Agency (regulator of Fannie Mae and Freddie Mac ) have called for lenders to further loosen lending standards.
While the housing market needs a shot in the arm, the financial crisis in 2008 taught us the extreme danger that loose lending standards—poor underwriting, risky loans and government-backed credit expansion—pose to homeowners and the economy. We think there is another way.
For most of the past 50 years, U.S. housing policy has relied on ever looser underwriting standards in an attempt to lift homeownership and stimulate the economy. The focus has been on attracting more low- and moderate-income home buyers in an attempt to build wealth for these households. Yet the homeownership rate has changed little since 1960, while homes in the past half-century have proved to be highly volatile assets. This is particularly the case for lower-priced homes bought by low-income households with highly leveraged 30-year loans.
A better option is what we call the Wealth Building Home Loan—a 15-year, fully amortizing, fixed-rate loan that will build equity much faster than a 30-year mortgage. The WBHL concept was unveiled in early September by Mr. Pinto and his colleague at the American Enterprise Institute, Stephen Oliner. The market embraced the idea, and WBHL-style loans are already being originated and distributed by the Neighborhood Assistance Corp. of America (NACA), a national nonprofit based in Boston that works primarily with low- to moderate-income borrowers. Citigroup and Bank of America have signed on to fund NACA’s 15-year mortgages.
In the first three years of a WBHL, 77% of monthly mortgage payments pay off principal while in a 30-year loan only 32% goes toward principal. After 15 years the home is owned free and clear, and starting in year 16 the family has cash flow available for life-cycle needs such as their children’s education.
The big question is whether a 15-year mortgage can be affordable. We think it can. First, the rate on a 15-year loan is already below that for a 30-year loan. Further, studies by Fitch Ratings, the Urban Institute and others indicate that 15-year loans have half the risk of similar 30-year loans. Add common-sense underwriting features such as gauging a borrower’s ability to repay by evaluating his entire budget, as opposed to looking at a monthly debt-to-income ratio that ignores such items as income taxes and living expenses. Today only the Department of Veterans Affairs considers a borrower’s total household budget. We estimate these steps will result in a two-thirds reduction in a lender’s foreclosure risk.
Another feature of the WBHL would allow a home buyer to use some or all of his down payment to “buy down” the interest rate on his loan. These differences allow the WBHL to provide more than 90% of the home-buying power of a 30-year fixed-rate FHA loan with a monthly payment almost as low.
Because of the rapid increase in equity and the dramatically lower risk of default, a WBHL can be safely offered with little or no down payment to a wide range of prospective home buyers. Within 10 months, this loan, even with no down payment, has a lower loan-to-value ratio than an FHA loan with 5% down. After the 41st month, the loan-to-value of a WBHL drops 80% while the it is still over 90% for an FHA loan.
A safe, sustainable version of the WBHL designed specifically for low-income borrowers can provide 96% to 100% of the home-buying power available with an FHA mortgage, the most common loan type used by low-income first-time home buyers. A modest subsidy to the home buyer provided by a foundation or the federal government could accomplish this goal.
So what’s standing in the way of offering WBHLs to as many qualified lower-income borrowers as possible? Regulations designed to promote sound lending that end up standing in the way. One is the Consumer Financial Protection Bureau’s “ability to repay” rules that ignore the benefits of evaluating the borrower’s entire budget. The other is the Federal Housing Finance Agency’s mortgage-insurance-company requirements that fail to consider the much lower default risk of a 15-year loan compared with a 30-year loan.
If regulators learn anything from the mortgage meltdown that led to the 2008 financial crisis, it should be that the goal of increasing homeownership—particularly among lower-income Americans—cannot safely be advanced by loosening lending standards. It can be by the Wealth Building Home Loan.
ABOUT WILLIAM M. ISAAC
Mr. Isaac, a former chairman of the Federal Deposit Insurance Corp., is senior managing director at FTI Consulting and the author of “Senseless Panic: How Washington Failed America” (John Wiley & Sons, 2010). Mr. Pinto, former chief credit officer of Fannie Mae, is co-director and chief risk officer of the International Center on Housing Risk at the American Enterprise Institute.
EDITORS NOTE: This column originally appeared in the Wall Street Journal.