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March 21, 2016

Bank of America’s new low–down payment mortgage is promising but no substitute for healthy FHA lending

March 21, 2016

Bank of America recently announced a new Affordable Loan Solution (ALS) mortgage, a 3 percent down payment mortgage that does not require private mortgage insurance (PMI). Targeted at low- and moderate-income (LMI) borrowers and offered in partnership with Self-Help Ventures Fund and Freddie Mac, the ALS mortgage is seen by some as an attempt to create a channel for lending to LMI borrowers that bypasses FHA and its heavy enforcement hammer. Though such efforts are an alternative to FHA lending, they are not a substitute, as the underlying economics of this deal make it difficult to scale up lending in a manner that would replace FHA.

Under the ALS arrangement, Bank of America will sell the mortgage and servicing rights to Self-Help Ventures (a nonprofit fund and affiliate of Self-Help Credit Union) immediately after origination, retaining no risk or any interest in the mortgage. Self-Help will then sell the mortgage to Freddie Mac but will retain an undisclosed level of first-loss risk. Only after losses exceed the first-loss level will Freddie Mac, the guarantor of the loan, take a loss. The loans will be serviced by a specialty servicer experienced in LMI mortgages. Borrowers must have a minimum credit score of 660 and income no greater than the area median income. There is also mandatory counseling for first-time home buyers.

Self-Help initiated a program similar to ALS in 1998—the Community Advantage Program (CAP)—in partnership with Fannie Mae and the Ford Foundation. In the CAP program, Self-Help covered default risk on $4.5 billion of LMI mortgages. CAP mortgages had a median loan amount of just $79,000, median loan-to-value (LTV) ratio of 97 percent and a low median household income of just under $31,000, according to UNC Center for Community Capital (CCC), which has analyzed approximately 50,000 CAP mortgages over the years. Despite low incomes and high LTVs, CAP mortgages were quite successful and had lower default rates than subprime loans.

CCC attributes CAP’s success to a plain vanilla 30-year fixed-rate mortgage that provides payment certainty, borrower counseling, and most important, superior loan servicing that addresses delinquencies promptly and aggressively. Self-Help is able to invest in more expensive specialized servicing partly because it does not have to earn a shareholder-driven profit for itself. As a result, it can divert those savings to better serve borrowers experiencing financial difficulties.

In an environment in which LMI borrowers are finding it difficult to get a mortgage, this is a welcome effort to find a creative new channel through which many can finally obtain a mortgage. However, it is important to note that this kind of channel is likely to be limited in scope, for several reasons.

The most significant barrier to larger-scale adoption of programs like this is the shortage of available capital. The ALS model relies solely on capital provided by Self-Help. Nonprofit capital is often sourced via loans or grants from foundations, community development organizations, or the government. Limited funding from these sources means the potential mortgage origination volume through such initiatives is also limited.

The second likely barrier is that it will prove difficult for lenders using this type of execution to compete with FHA on price. The most borrower-friendly feature of the ALS mortgage is that PMI, which can cost several hundred dollars per month, is not required. It’s not clear, however, if ALS borrowers will be charged a higher mortgage rate in lieu of PMI. If they are, the potential for savings will be lower.

Increasing the loan volume for ALS-like programs will also require lenders to offer much deeper savings to make these loans cheaper than FHA because GSE mortgages require riskier borrowers to pay higher fees, whereas FHA doesn’t. Superior borrower economics under FHA, especially after the January 2015 premium cut, is one of the main reasons why GSEs’ 97 LTV programs reintroduced over a year ago haven’t generated material volume.

None of this is to criticize the program, which is a creative effort to improve access for a group of borrowers for whom credit is overly constrained. It is just a reminder to keep the effort in perspective. While programs like this are needed, they are unlikely to offer a substitute for a healthy market in FHA lending, in which lenders are willing to lend further down the credit spectrum to those who fit within FHA’s mission.

Many lenders are increasingly uncomfortable lending to FHA borrowers who pose even modestly more credit risk, given a range of risks and costs associated with FHA lending. The modification to FHA’s underwriting rules released last week will hopefully begin to give lenders more comfort. And if it does, the resulting increase in FHA lending would likely be orders of magnitude greater than through channels like the one Bank of America and Self-Help have created here.

The way to increase lending to LMI borrowers is thus through more programs like this, but also, and more important, by fixing FHA.

The views expressed in this blog post are those of the author and should not be attributed to the Urban Institute, its trustees, or its funders. Bank of America is a member of the Urban Institute’s National Council, a network of high-level community, policy, and business leaders whose flexible financial support allows the Institute to anticipate and respond to emerging policy issues with timely analysis and relevant insights. As stated in our funding principles, no funder determines research findings or the insights and recommendations of our experts.

As an organization, the Urban Institute does not take positions on issues. Scholars are independent and empowered to share their evidence-based views and recommendations shaped by research.

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In this Tuesday, Sept. 30, 2014 file photo, homeowner Helena Platt, left, of Atlanta, hands paperwork to Bank of America associate Mirella Gonzalez in an attempt to lower her monthly mortgage payment at a mortgage relief event by the Neighborhood Association Corporation of America, in Atlanta. Photo by David Goldman/AP/File