The Tight Housing Market Boxes Out Government-Insured Borrowers, Widening Homeownership Gaps
The housing market has experienced robust home price appreciation and tight supply over the past year. This is good news for sellers, many of whom are getting multiple offers on their homes, but it may be bad news for borrowers relying on loans backed by the Federal Housing Administration (FHA) and US Department of Veterans Affairs (VA). A recent survey by the National Association of Realtors of its agents found that 89 percent of sellers would be likely to accept an offer from a buyer with a conventional loan, but only 30 percent would be likely to accept an offer from a buyer using an FHA or VA loan. Meanwhile, 6 percent of sellers said they would not even consider an offer from an FHA or VA buyer.
A simple analysis of Home Mortgage Disclosure Act data shows that flat-out rejection of buyers seeking government-backed loans disadvantages households with lower incomes, lower credit scores, and less wealth, many of whom are people of color. As a result, it is more difficult for these borrowers to compete for homes, which exacerbates the racial homeownership gap.
What the data reveal
To understand current trends, we calculated the share of government and government-sponsored enterprise (GSE) purchase loan originations by channel over the past 4.5 years. We excluded bank portfolio loans and private-label securities from this analysis because we don’t have complete data for these loans.
From mid-2017 through May 2020, the FHA share ranged from 21.5 to 24.0 percent of the agency market, averaging 22.8 percent. It has dropped to 18.9 percent the past two months. A similar but more muted pattern is apparent in the VA share, which held steady from mid-2017 through May 2020, averaging 11.5 percent, but has dropped to 10.3 percent in the past two months. This indicates a considerable move away from government-insured mortgages. Though a small part of the drop may be driven by home values rising above FHA loan limits, the loan limits increased in January 2021, while the FHA and VA shares continued to drop.
Who is most disadvantaged?
FHA and VA mortgages serve borrowers with lower incomes, less wealth, and lower credit scores, because these mortgages have flexibility around credit scores, debt-to-income requirements, and down payments. And because of our nation’s history of racial discrimination, many borrowers with these characteristics are people of color. For 2019 purchase originations (the latest Home Mortgage Act data available), 15.0 percent of FHA borrowers and 13.1 percent of VA borrowers were Black, compared with only 4.9 percent of conventional borrowers, and 23.0 percent of FHA borrowers and 11.9 percent of VA borrowers were Hispanic, compared with 11.1 percent of conventional borrowers. We also find that 41.9 percent of FHA borrowers and 36.3 percent of VA borrowers were younger than 35, compared with 33.6 percent of conventional mortgage borrowers.
In a hot housing market, borrowers using FHA or VA mortgages are at a disadvantage to those using conventional mortgages. And the borrowers who disproportionately use these mortgages are the families of color who have historically been excluded from homeownership and could most benefit from today’s low interest rates.
Why would sellers intentionally exclude a whole group of potential buyers?
In its Loan Type Survey, the National Association of Realtors asked its agents what makes FHA and VA loans “less attractive” to sellers than conventional loans. Home inspection requirements topped the list, followed by appraisal issues, longer time to close, and low down payments.
Home inspections: Government mortgages require a home inspection by an authorized inspector. They look for defects that could cause health, safety, and security risks. Some of the most common defects include the lack of safety handrails in open staircases with three or more stairs; appliances, floor coverings, and roofs with less than two years of useful life left; homes built before 1978 (roughly half the US single-family housing stock) with peeling or chipping paint; and windows that do not function properly. No home inspection is needed for a conventional loan, as the price is assumed to reflect the condition of the home.
Appraisals: For a government loan, if the home is appraised for less than the agreed-upon price, the seller must reduce the purchase price to match the appraised price or the deal cannot proceed. And if the borrower lists the home again, the appraisal stays with the home for 120 days. With a conventional loan, if the home is appraised for less than the agreed-upon price, the parties can renegotiate the price, and the buyer can pay the difference between the renegotiated purchase price and appraised value. This gives the seller more flexibility if the property fails to appraise.
Time to close: Government loans also take longer to close, often because of the need for repairs. Ellie Mae’s loan origination report indicates that in the first three months of 2021, it took an average of 6 to 7 days longer to close an FHA or VA purchase loan (57 to 58 days) than a conventional purchase loan (51 days).
Low down payment: Conventional loans typically require either a 20 percent down payment or private mortgage insurance, while government-backed loans allow lower down payments. This is a big reason government loans are used disproportionately by first-time, low-wealth, and younger borrowers. Unless low down payment is a proxy for certainty of closing, it is unclear why a seller would care about a buyer’s source of mortgage funding.
What can be done to level the playing field?
The federal government should consider several steps to make the government loan process more efficient and make first-time borrowers, borrowers with less wealth, and borrowers of color more competitive in the housing market. For example, the FHA and VA could more closely align their rules with those of Fannie Mae and Freddie Mac so government loans are no longer at a disadvantage. The US Department of Housing and Urban Development (HUD) and the VA could consider either eliminating the home inspection or making it less prescriptive. Similarly, HUD and the VA could consider making appraisal requirements more flexible, using the same rules as currently apply to GSE mortgages.
Reducing these barriers can help government borrowers gain more equal footing with conventional borrowers. It is just one of many steps that could shrink the racial homeownership gap and make the mortgage market fairer and more equitable for all borrowers.
The Urban Institute has the evidence to show what it will take to create a society where everyone has a fair shot at achieving their vision of success.
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