Why is Credit Tight for LMI Borrowers?

Tight credit for low- and moderate-income (LMI) borrowers is one of the biggest challenges facing housing in 2017, according to Urban Institute Housing Finance Policy Center (HFPC) in its November 2016 Chartbook released Monday.

Why has credit been so tight for LMI borrowers? According to the HFPC, it could be a number of factors.

“These include lender worries about put back risk, legal and reputational risk, high cost of servicing, higher capital requirements for mortgage assets, and in the case of FHA specifically, the DOJ’s heavy handed enforcement under the False Claims Act,” the HPFC said.

The industry is waiting to see how the new Trump Administration will affect the housing industry, particularly since Trump has vowed to ease regulations. The credit access issue could improve under the new administration if Trump chooses a new Attorney General or other regulators that are more business friendly, which could result in an increase in FHA lending (currently the only source of LMI lending) if lenders are confident they won’t receive unreasonable penalties, according to the HFPC. Reduced capital requirements may also result in increased lending.

Aside from tight credit for LMI borrowers, another issue facing housing is a lack of sufficient affordable inventory. The HFPC attributes this challenge to a number of factors, including: builders have little incentive to build cheaper starter homes due to the increased fixed cost of construction—which can be attributed to changes to building and development codes and delays and increased costs in obtaining zoning approvals. Not only that, but insufficient equity levels are preventing borrowers from financing a trade-up. A lack of repeat buying activity also has the potential to limit the number of affordable existing homes for sale, the HPFC said, because underwater homeowners are unlikely to sell at a loss, preventing many starter homes from entering the market.

Increasing inventory may be more of a challenge for the new administration than expanding credit for LMI borrowers, because zoning restrictions and codes are set at the local level.

“However, actions like using transportation funding to incentivize higher density housing near transportation hubs could have a positive impact,” the report stated. “The administration could also elevate the issue of supply constraints, and work with the housing industry and state and local governments to simplify development and zoning standards and speed up the approval processes.”

Click here to view the complete November 2016 Housing Chartbook from Urban Institute.