A manufactured home with a nicely groomed yard and carport.

Lack of access to small mortgages can stymie homeownership 

Buyers seeking small mortgages have been increasingly shut out of traditional lending channels, leaving them with riskier options.

April 16, 2023
4 minutes

Key points:

  • Outdated housing policies and financial regulations have led to a shrinking share of small mortgage loans.
  • That trend has most heavily impacted Black and Hispanic households, and households with lower income levels.
  • As a result, more people are turning to alternative financing options, which are less regulated.

Lower-value mortgages are getting harder to come by, thanks to outdated housing policies and financial regulations. The result? Communities of color and households with lower incomes are forced to turn to riskier finance options.

Less access to traditional loans for homes under $150,000 has led more buyers to pursue alternative, less regulated financing that can lead to trouble down the road, according to research from the Pew Charitable Trusts.

According to the research, around 7 million people are currently using alternative financing, which includes options like land contracts, lease-purchase agreements and personal property loans. With many of these options, the buyer doesn't have the deed to the house until the loan is paid off.

"Mortgages are the gold standard in home financing because they have low costs, strong consumer protections, and make clear the rights and responsibilities of homeownership," said Tara Roche, director of The Pew Charitable Trusts' housing policy initiative.

"Conversely, alternative financing agreements vary in their protections, costs, and requirements. While some options may work for buyers and lead to full, legal ownership of the home, other buyers don't fare as well."

Hispanic, Black homebuyers most likely to use alternative financing

Those who turn to alternative financing tend to have an annual household income of less than $50,000, making them more vulnerable if a financial emergency takes place. Pew's research found that Hispanic homebuyers (34%) are most likely to have used alternative financing, followed by Black homebuyers (23%) and non-hispanic white buyers (19%).

"Risks can include quick evictions or foreclosures, the inability to build or access home equity, and unclear responsibilities when it comes to taxes and repairs," Roche said in an email.

The share of small mortgage loans has steadily dropped over the past 16 years, according to an October report from the U.S. Department of Housing and Urban Development (HUD). The percentage share of mortgages under $70,000 has fallen from about 11% in 2004 to 3.5% in 2020.

Less access to lower-value mortgages particularly impacts the manufactured home market, according to the Pew report. It found that more than 75% of new manufactured homes are owned as personal property rather than real estate. It's an important difference, because manufactured homes that are owned as personal property aren't eligible for federal loan programs.

"As a result, buyers have few financing options," the report concluded.

Why don't lenders offer small mortgages?

The biggest factor is the cost involved in originating a loan, said Roche. The fixed costs of a mortgage impact profitability, which incentives lenders to pursue bigger loans, according to the report. The same amount of work goes into putting together a $300,000 loan as it does for a $50,000 loan.

Other factors that have led to fewer small mortgages include rising home appreciation; the quality of some low-cost homes, which can make it difficult to get financing; and all-cash buyer competition.

"However, even if these external factors were addressed, many families would continue to be shut out of homeownership without better access to small mortgages," Roche said.

It's an issue the federal government has been looking into. In its report, HUD noted that origination fees for low mortgage loans impacted profitability. 

Because lower profits appear to be the main reason for the drop in small mortgage loans, the HUD report noted that "either a reduction in origination and servicing costs or the provision of additional lender or loan originator compensation sufficient to make small mortgage loans profitable at levels acceptable to lenders" may be necessary.

Roche said that while federal regulators have acknowledged the problem, she hasn't seen a scalable solution to reducing the cost of originating small mortgages. There have been some focused programs that lenders have explored, but more needs to be done.

"Opportunities that encourage lenders to originate more small mortgages" would be a welcome step, Roche said.

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