The voices of Urban Institute's researchers and staff
May 5, 2016

The worrisome return of a racist form of home lending

May 5, 2016

In Ta-Nehisi Coates’s widely read “The Case for Reparations,” he tells the story of Clyde Ross, a black man born in 1920s Mississippi who moved to Chicago as a young man to escape the Jim Crow South for a better life. After arriving, Ross bought a house under a “contract for deed” that allowed the seller to exploit him for years.

Redlining, racial restrictive covenants, and the absence of traditional lending to minorities historically allowed the practice to thrive until the 1968 Fair Housing Act. But 50 years later, on the heels of the housing market crash, contracts for deed are making a worrisome return.

Under contracts for deed, the seller finances the home purchase, rather than a bank or traditional lender. Until the contract is paid in full, the seller owns the deed. The buyer won't build equity and, in many states, can be legally evicted for missing a payment.

The problem with contracts for deed

In the 1950s and 1960s, predatory contract sellers developed new rules, balloon payments, and surprise inspections midcontract to cause buyers to fall behind. Meanwhile, the sellers kept all the previous payments and would “resell” the house, starting the process all over again.

The New York Times recently published a series of articles showing that financial firms today are buying large bundles of foreclosed properties and reselling them under contract “as-is” at much higher price points and at interest rates approaching 10 percent. One article reported that a set of bundled homes averaged $8,000 per property when initially sold to a firm. But one home eventually sold under contract to a potential homeowner for $36,000.

These contracts may also require the buyer to bring the property up to a livable standard within just a few months and include arbitration clauses that limit the buyer’s ability to settle disputes in court. To echo Coates, the seller’s terms provide buyers “all the responsibilities of homeownership with all the disadvantages of renting—while offering the benefits of neither.”

Why is contract selling coming back?

Many foreclosed properties sold under contract are in the South, Midwest, and other areas especially hard hit during the housing crash. The practice is making a comeback for likely the same reasons it initially appeared several decades ago: a restrictive market that limits potential homebuyers from obtaining traditional mortgages. Now, instead of redlining and racially restrictive covenants, we have historically high lending standards and very few small-value mortgages.

Many of the properties sold under contract need work or aren’t valuable enough to be bought with traditional mortgages. Mortgages under $50,000 are disappearing, even though the number of properties worth less than $50,000 is growing. This is particularly true in some small and midsize cities, but the trend holds at the national level.

Percent of new mortgages under $50,000

Number of new mortgages under $50,000

Many potential homebuyers who would still need to borrow to purchase one of these lower-value homes are locked out of the market. And it’s no coincidence that many of these homebuyers are black and Latino, the same groups trapped in the initial contract-for-deed boom. Though the current contract sellers are not explicitly targeting minority homebuyers, they are selling to groups historically underserved by the conventional mortgage market and oversold to during the subprime lending crisis. And increasingly tight access to credit continues to hurt blacks and Latinos in the housing recovery.

Homebuyers seeking to buy a starter home, find more stable housing to avoid eviction, or live in less expensive markets need access to nonpredatory mortgage markets. These families are no less deserving of gaining access to the American Dream. Banks, the government, and government-sponsored enterprises should work quickly to fill this lending gap for more affordable homes.

If contract selling is allowed to make an underregulated resurgence, many minority families and families with limited capital will fall even further behind in economic mobility and wealth accumulation and continue to suffer the myriad consequences associated with housing instability. We should learn from our history before we’re doomed to repeat it.

Photo via Shutterstock

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