My recommendations for dealing with the low-income homeownership problems in Texas

I was invited to testify today before the Texas Senate Intergovernmental Relations Committee on the status of state programs to provide owner-occupied housing for low income families.

Here is my testimony.

Testimony of John Henneberger, co-director before
the Texas Senate Intergovernmental Relations Committee

on the committee interim housing charges

October 8, 2008

On the behalf of the Texas Low Income Housing Information Service1 Thank you for the opportunity to revisit the affordable housing charges before the committee in testimony today.

In the time between this committee’s last hearing and today we have seen the unfolding of a mortgage crisis that has produced the most profound changes in the affordable housing field in the past seventy-five years.  This has been magnified in Texas with the housing destruction brought about by Hurricane Ike and the massive job of repair and reconstruction of housing that will soon fall upon our state government.

These two recent housing events bear directly on the Intergovernmental Relations Committee’s affordable housing charges in the areas of homeownership, the Texas Housing Trust Fund, capacity building, and the Bootstrap home loan program.  My testimony will reprise my recommendations in these four areas in the context of the mortgage crisis.

Since it is beyond the scope of this committee’s interim charge to deal with disaster housing issues I will not provide testimony about disaster related housing other than to state that it must be a major focus of our state’s housing efforts.  The recommendations that I make in this testimony for building up state capacity to plan and administer housing programs and to establish new housing financing programs for low-income families will be made more urgent by our state’s responsibilities for overseeing housing reconstruction under the forthcoming disaster housing programs. I stand ready to supply our recommendations regarding disaster related housing rebuilding, an subject that has been a primary research area of my organization for more than three years.

Returning to the mortgage crisis, let me begin by noting that its impact on affordable housing in Texas is only slowly becoming clear to us.

In the present homeownership crisis there are four evolving conditions that produce uncertainty and pose severe challenges on state government.  Not knowing the exact nature and dimensions of the foreclosure crisis and the contraction of mortgage availability makes planning to address these challenges extremely difficult.

Here is what we face.

First, we do not know how long the current high rate of foreclosures will continue but we do know we have a problem of unprecedented size.  For the first half of 2008 there were almost 100,000 Texas foreclosure filings.  While Texas has not been hurt as much as some other states, our large number of homeowners means we still have the sixth highest number of foreclosure postings among the states.

Second, we have no reliable economic or demographic data to indicate the degree to which lower-income families have been effected by the foreclosure crisis.  We have lots of evidence that subprime borrowing, particularly for home equity lending, was especially high in Texas over the past decade in minority and low income communities.

Third, we are in a period during which mortgage credit for lower-income borrowers has dried up, bringing additional low-income homeownership to a standstill.  The GSEs (Fannie Mae and Freddie Mac) affordable housing lending goals have been suspended, eliminating a vital secondary market for affordable housing loans.  Subprime lending has generally been curtailed.  Non-traditional and bank portfolio lending is also drying up.  When and if affordable housing mortgage markets open up again and what sort of additional constraints will be placed on borrower qualifications we do not know.

In recent years public investment in housing construction for low-income homeownership has been very low.  State production programs have created only a few hundred affordable owner-occupied homes.  State and local governments have generally pursued a policy of providing interest subsidized mortgage loans for moderate-income homebuyers and down payment assistance (DPA) grants for lower-income homebuyers.  I will describe later the inefficiencies of down payment assistance grants in securing safe, foreclosure-resistant home loans.

The point is that state and local efforts have most often been directed at enhancing the ability of borrowers to secure private market financing through interest or down payment incentives.  Government involvement in the direct production of low-income owner occupied housing and in the direct provision of mortgage credit has been relatively small.  Therefore, low-income housing production for homeownership will be remain virtually halted until either the private mortgage markets are reestablished or until the state gears up for more production and establishes an alternative mortgage credit market for low-income borrowers.

Fourth, Congress has recently passed several rescue programs aimed at preventing more homebuyers from defaulting on their mortgages and designed to repurchase foreclosed properties to prevent them from depressing surrounding neighborhood home values.  Most of these efforts will require state, and in some instances local government to administer and design the programs.  The rules and regulations are only this week beginning to emerge from HUD.

Texas will face a significant challenge to quickly set up this large new program and properly administer it.  The truth is that no state has any experience in designing and administering these type of foreclosure remediation programs.  There are few models we can look to adopt.  We are faced with the task of designing new programs under very great time pressures.

Congress has also made available additional tax credits and mortgage revenue bond authority to help create housing and refinance mortgages.  Administration of these program funds will also be an added state responsibility.

So how should Texas respond to the mortgage crisis?

I have seven recommendations:

  1. learn the lessons;
  2. impose proper financial regulations to prevent the abuses that caused this crisis;
  3. go beyond talking about teaching financial literacy and actually do it;
  4. acknowledge that many lower-income households are not yet ready for homeownership and adjust public expenditures to allocate funds to provide affordable rental housing for these families;
  5. fund the Texas Housing Trust Fund to provide the type of home mortgage financing for low-income families and affordable rental housing that we know works;
  6. develop foreclosure-resistant mortgage products; and
  7. quickly and wisely implement the new federal programs designed to prevent foreclosures and provide mortgage credit.

First, learn the lessons. We cannot achieve our important goals of expanding homeownership among lower-income families and building “The Ownership Society” on the cheap by relegating all our public responsibilities to private mortgage markets. We tried that and that is what got us to where we are today.

Homeownership is a significant financial commitment and responsibility for which a family must be properly prepared.  The mortgage crisis has taught us that all homebuyers, and especially low-income homebuyers, must have adequate savings, be capable of making informed financial decisions about complex home finance options and a have a direct personal commitment in the form of a down payment or other form of personal equity contribution such as sweat equity.

As government looked the other way, the private mortgage markets did not insist that low-income homebuyers, or many other homebuyers for that matter, possessed these essential resources.  The results was disastrous for the families who suffered foreclosure and for our entire economy.

If we are committed to creating successful low income home ownership, government must assume some responsibility for equipping low income families with these prerequisites for home buying success.  Government must also assume additional responsibilities in the areas of housing supply and buyer subsidies as well.

Government housing programs must employ resources to stimulate the private for profit and nonprofit sectors to produce a supply of affordable housing.  Finally, government has a critical role in creating financing programs, with reasonable underwriting standards that work for low-income families.  Texas has already succeeded brilliantly, albeit on a very small scale, in both of these areas through the Texas Bootstrap Owner Builder Loan Program.  We must build on this success.

Given the demands to respond to evolving market conditions, to innovate and to implement new programs quickly, I propose that the State of Texas establish a task force to advise the Legislature, the Governor and the Texas Department of Housing and Community Affairs (TDHCA) how to respond to the home foreclosure crisis.  This task force should be composed of economists, demographers, housing experts, mortgage finance experts, housing and banking leaders and elected officials.  The task force should meet quarterly to review market conditions and report its recommendations.

Second, impose proper financial regulations to prevent the abuses that caused this crisis. Much mortgage lending regulation will no doubt be imposed by Congress, but there is also a state responsibility.

The state must require mortgage brokers to assume and faithfully exercise a fiduciary obligation to act in the best interests of their clients and not simply in a manner that best enriches the broker.  No more should we allow brokers to refer borrower only to higher priced ARMs and subprime loans when the borrower could have qualified for a lower cost prime loan simply because the subprime loan paid the mortgage broker a higher commission.

The state should monitor federal legislation and enact, should the federal government fail to do so, protections against future predatory or subprime lending for consumers modeled after those adopted in North Carolina.

We proposed last session a requirement for mandatory mortgage counseling for lower income borrowers considering high risk or exotic loans.  The Legislature should once again consider, given current market conditions, whether such a requirement should be enacted.

We recommend that lending institutions be required under state law to honor existing tenant leases and not force renters of foreclosed properties to vacate on short notice through lease terminations triggered by foreclosure.

Third, go beyond talking about teaching financial literacy and actually do it. There are two ways to prevent the exploitation of homebuyers who lack the sophistication to make financial decisions regarding competing home mortgage and home equity loan products.  We can restrict the loan offerings to eliminate the most dangerous products from the market or we can make sure the public is sufficiently educated to exercise intelligent choices.  We should pursue both approaches.

But we must recognize that even the most aggressive regulation of mortgage markets will not control completely the problems produced by uninformed consumer choices.  Investment in financial literacy is an essential tool to help low-income families succeed, not just in the home buying experience, but in many other areas of life as well.  Financial literacy is an essential anti-poverty investment.

Fourth, acknowledge that many lower-income households are not yet ready for homeownership and adjust public expenditures to allocate funds to provide affordable rental housing for these families. We have focused too much on homeownership as the ideal housing solution for everyone.

As I have pointed out in previous testimony before this committee, overwhelmingly the worst case unmet housing needs in Texas are among the lowest income families who rent their home.  Yet disproportionate amounts of government housing dollars are directed at the housing needs of higher income families to subsidize homeownership.  Given the limited resources available we need to prioritize the worst case housing needs of the poor.

Some programs can actually allow these very poor families to acquire and retain a home that they can own.  Both the Texas Bootstrap program and the work of Habitat for Humanity are two examples.  We should expand these programs.

We should also work to increase affordability and achieve lower rents in the Low Income Housing Tax Credit program so that those families with worst case needs who cannot be served through the Bootstrap or Habitat for Humanity programs, due to lack of funding or capacity, can live in these apartments.  Not all families are ready to be homeowners.  The capacity of our low income, owner-occupied housing programs is extremely limited.  We must recognize these facts and adjust our priorities accordingly.

Fifth, fund the Texas Housing Trust Fund to provide the type of home mortgage financing for low-income families and affordable rental housing that we know works. We cannot wait for the federal government to provide the funds.   We had hoped that funds for rental housing production for extremely low-income families would, at long last, be available in greater amounts with the passage several months ago of the National Housing Trust Fund.  But funding for the National Housing Trust Fund has dried up in the light of the collapse of Fannie Mae and Freddie Mac.  So we are not going to get the help we need from the federal government in the near term.

The Texas Department of Housing and Community Affairs has requested $20 million in state General Revenue funding each year for the Texas Housing Trust Fund.  We support $50 million per year funding.

The most equitable approach to raising this supplemental funding would be a document filing fee imposed of real estate documents filed with county clerks.

Sixth, develop foreclosure-resistant mortgage products. The Texas Bootstrap owner-builder loan program is an example of a good, foreclosure-resistant loan product.  With at least forty percent of the home’s value invested by the owner-builder through labor to build the house, the mortgage costs are dramatically lower than a conventional loan.  The home buyer’s sweat equity investment is actually better than a cash down payment in ensuring that the buyer has an incentive to stick with the home.

To keep the Bootstrap program working and helping more Texans the Legislature needs to:

  • make some some minor adjustments in program guidelines,
  • increase the maximum loan amounts that have not increased in more than ten years;
  • ensure that there is adequate funding in the Texas Housing Trust Fund to provide for more loans.

Texas should adjust other low-income homeowner subsidies to create a second type of foreclosure-resistant loan for low-income families.

Robert J. Shiller, professor of economics at Yale, writing the New York Times, suggests that…

In this time of economic crisis, help for troubled homeowners often arrives late, when it arrives at all. All too frequently, families are going into default on their mortgages, facing foreclosures and evictions that may have traumatic consequences.

It doesn’t need to be this way. Mortgages could be structured differently, so that adjustments in payments would be made as a matter of routine – systematically, automatically and continuously – starting even before any distress is perceived by borrower or lender. By avoiding thousands and even millions of individual family crises, we might also make institutional crises, like the collapse of Lehman Brothers and Bear Stearns, less likely.

One of the best kept secrets is that just such a mortgage exists and has proven successful for many decades. It is called the USDA 502 Direct Loan. It is administered by the US Department of Agriculture Rural Development program.  It is only available for homes in small towns and rural areas.

Ironically, the Bush and Clinton Administrations have all but killed off this highly effective program through the budget cutting process.

We recommend that TDHCA establish a lending program based generally on the Section 502 guidelines and rely on this approach as a partial alternative to down payment assistance grants.

Today the State of Texas and most larger local governments rely on down payment assistance (DPA) grants as a method of subsidizing homeownership for lower income families.  In our opinion this is both a bad investment and too costly.  The grants generally range from $10,000 to $40,000 and sometimes are secured (tenuously) as “soft second liens.”

The problems with DPA have become all too apparent during this mortgage crisis:

  • a foreclosure wipes out the government DPA;
  • there is no way to ensure that the seller does not simply adjust the sales price of the house upward to pocket the value of the DPA;
  • since most homeowners move every six or seven years, the DPA loan represents a very expensive short term housing subsidy;
  • in some cases there is no assurance that the underlying loan was based on the best terms the buyer was eligible for, in which case the value of the DPA may accrue to the lender and not to the home buyer;
  • unlike a direct loan such as the Section 502 loan, the DPA does nothing to protect a homebuyer from foreclosure; and
  • a DPA does does relatively little to qualify a lower income home buyer for a home purchase.  It addresses the borrower’s lack of savings for a down payment but does little to qualify lower income families for home ownership.

The Section 502 Direct Loan program overcomes all of the problems of DPA.  A 502 loan requires more capital to issue (unless it is blended with a private mortgage loan) but it is highly foreclosure-resistant, can help lower income families obtain homeownership and it is far more likely that the investment will be recovered by the government to use to assist another low income home buyer.

Under Section 502, individuals or families receive financial assistance directly from the Rural Development program in the form of a home loan at an affordable interest rate. The payment is subsidized based on the buyer’s adjusted gross income and the number of household members.  Depending on the borrower’s ability to pay, payments can be reduced to a level equal to a principal and interest payment at 1% interest rate, plus property taxes and home owners insurance.

Up to the full subsidy amount can be recovered by the USDA Rural Development program when the homeowner sells the house.

Applicants for direct loans must have very low or low incomes. Very low income is defined as below 50 percent of the area median income (AMI) (that is $27.500 or less for a family of three in the Houston PMSA); low income is between 50 and 80 percent of AMI (a maximum of $44,000 for a family of three in the Houston PMSA).

Families must be without adequate housing, but be able to afford the mortgage payments, including taxes and insurance, which are typically within 22 to 26 percent of an applicant’s income. However, payment subsidy is available to applicants to enhance repayment ability. Applicants must be unable to obtain credit elsewhere, yet have reasonable credit histories.

Loans are for up to 33 years (38 years for those with incomes that are very low and who cannot afford 33 year terms).  The promissory note interest rate is set based on the government’s cost of money.

The borrower’s payment of principal, interest, taxes, and insurance is the higher of: 24 percent of borrower’s adjusted annual income; or principal and interest calculated at 1 percent on the Rural Development loan plus taxes and insurance.

Besides being super affordable, the mortgage payments can be adjusted based on the borrower’s ongoing financial circumstances.  Loan payments can be recalculated at any time if the borrower has a change in financial circumstances.  If disaster strikes and a borrower becomes sick or otherwise cannot afford to pay, loan payments can be temporary suspended and the term of the loan extended to cover the missed payments.

Seventh, we need to quickly and wisely implement the new federal programs designed to prevent foreclosures and provide mortgage credit. This means the planning and program implementation capacity within TDHCA must be increased.
TDHCA is a very competent housing finance agency.  Yet the responsibility for so many new programs, not to mention Hurricane Ike related housing programs will overburden the department.  There is an immediate need to undertake continuing market assessments and adjust programs and resources to respond, yet there is no extra planning staff within TDHCA to undertake this mission.

Existing housing programs developed slowly over many years.  Many were based on models that have been in place for a long time in other states.  The current foreclosure challenge is very different.  Implementation must be very fast to be effective and there are no established models for these type of housing programs to adopt.  As I outlined earlier, we recommend that a high level task force of experts and industry leaders monitor market conditions and advise TDHCA.

The Texas Department of Housing and Community Affairs has been operating under a state employment (FTE) cap that has been in place for a number of years.  This is despite the rapid growth of new program responsibility the department took on as a result of assuming lead responsibility for administering Hurricane Rita reconstruction funding.  The added responsibilities of the new federal foreclosure programs coupled with the responsibilities for overseeing housing reconstruction of Hurricane Ike demand a major expansion of the staff resources available to the housing department.

Thank you for the opportunity to present this testimony.

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