John O'Leary is a former GOVERNING contributor. He is co-author of "If We Can Put a Man on the Moon: Getting Big Things Done in Government."E-mail: firstname.lastname@example.org
When the housing bubble burst, homeowners on the financial margin couldn’t keep up with their mortgage payments. Both lenders and home-owners alike were shellacked by the double whammy of lower home prices and high unemployment. Foreclosures skyrocketed.
Under the circumstances, one would expect that a government-run homeownership program, especially one targeting low- and moderate-income earners, would suffer mightily under the strain. However, the SoftSecond Loan program of the Massachusetts Housing Partnership, which was started in the early 1990s to address the concern of low mortgage lending to underserved borrowers in minority and other low-income communities, hasn’t suffered from the sort of high default rates one might expect.
Through SoftSecond, first-time home-owners can obtain a second mortgage worth 20 percent of a home’s purchase price, which when combined with a standard mortgage worth 77 percent, allows these first-timers to enter the housing market by putting down just 3 percent of the purchase price. It also only requires borrowers to pay interest for the first 10 years and enables them to avoid costly private mortgage insurance.
To qualify, borrowers must meet income limits. More than half the borrowers had incomes that were 60 percent or less of the area median income. “We aim for the lowest income homebuyer we can reach responsibly,” was the way one official put it. As such, one would think these marginal earners would have been swamped when the housing bubble burst.
But that’s not what happened. As of June 30, 2010, the statewide foreclosure rate for prime loans was 2.1 percent, while the rate for those in the SoftSecond program was just 1 percent.
There are a few reasons the program has thrived in the most brutal sort of environment. First, the strategy of being selective in identifying responsible, long-term homebuyers has paid off.
For example, the program requires that if the home is “flipped” or sold within five years, all interest subsidy funds must be repaid -- which discouraged those looking to make a quick buck from getting into the market. One of the forces driving the bubble was the willingness of loan originators to give oversized mortgages to those with dubious ability to repay. This was fine so long as home prices were appreciating at 8 or 10 percent a year. But when the housing market correction hit, these borrowers were the first to default. SoftSecond’s borrowers, however, have proven more resilient.
Second, all borrowers are required to attend homeownership training courses prior to closing on the loan. Unlike those hastily rushed into “no money down” loans, these borrowers understand what they’re getting into.
The Massachusetts Housing Partnership also connects these first-time buyers with access to municipalities that market reduced-price, deed-restricted, low-income properties. Borrowers are able to obtain slightly below-market interest rates from participating banks as well.
SoftSecond is run by Clark Ziegler, who attributes the program’s success to its collaborative approach. There is, Ziegler says, a “solid partnership between the state, the participating banks and the community groups that provide the homeownership counseling that sets the fundamental foundation for the program.”
The program hasn’t defined success in terms of volume, but rather in terms of quality. Since each loan requires a government subsidy, the idea is to choose borrowers who are good risks, not indiscriminately lend to all those who meet the financial qualifications. Since the program went statewide in 1992, SoftSecond has provided 15,000 Bay State residents a shot at homeownership -- a healthy contribution to the market, Ziegler says. It is hardly the sort of reckless giveaway programs that critics contend led to the meltdown at Fannie Mae and Freddie Mac.
Perhaps the most critical element to success wasn’t on the borrower side, but on the lender side. Because SoftSecond loans do not meet conforming criteria, such as debt-to-income ratio limits and documentation requirements, lending institutions have never been certain of a resale market for the loans. This makes lending banks wary when it comes to assessing the borrower’s creditworthiness, since the bank may be on the hook for the loan for years to come. Retained risk leads to better loans.
One factor driving the subprime mortgage mess was the fact that loan originators knew they’d be reselling questionable loans -- and their high risk -- to a secondary market as soon as possible. This helped fuel the ugliest aspects of the real estate bubble. During the real estate boom years, some of the riskiest and most sophisticated loans were made to the most unqualified, unsophisticated borrowers. Thanks to retained risk, that hasn’t happened with Massachusetts’ program.
The SoftSecond program isn’t free, and each loan ends up costing a little less than $5,000. Critics point out that rather than serving the poorest of the poor, the program serves a working population that would probably do well in rental units in the absence of the program, perhaps moving more gradually to homeownership.
But in terms of a program that has met its goals of increasing homeownership among marginal earners, the program is a success in an area in which the government has struggled mightily. In addition to the meltdowns of Fannie Mae and Freddie Mac, the many travails of the U.S. Department of Housing and Urban Development and the disastrous experiments with public housing projects are cautionary tales for those seeking to improve housing options for low- to moderate-income communities through government.
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