Alternative Pathways to Affordable Homeownership
A Pew Charitable Trusts survey conducted in 2019 found that one in five home borrowers pursued alternative financing options at least once as a pathway to homeownership when they could not access traditional mortgages. Compared with traditional mortgages, alternative financing methods often result in higher costs, lost equity, and eviction. On August 10, 2022, the Urban Institute held “The Push and Pull of Alternative Pathways to Affordable Homeownership,” an event discussing recent research on alternative financing arrangements and their disproportionate use by race and income. The event featured a panel that highlighted the viability of these financing methods for increasing affordable homeownership for low-income and minority borrowers when federal protections are in place. Urban Institute fellow Laurie Goodman moderated the panel discussion, which included Stacey Epperson, founder, president, and chief executive officer of Next Step Network; Akilah Watkins, president and chief executive officer for Center for Community Progress; and Bill Young, cofounder and chief executive officer of Home Partners of America.
Lack of Small Mortgages Are Fueling Alternative Financing Arrangements
Tara Roche, manager of consumer and home financing at the Pew Charitable Trusts, presented research showing that when buyers purchasing low-cost homes are unable to secure small mortgages, they often defer to one of four alternative financing methods: seller-financed mortgages, land contracts, chattel loans, and lease-to-purchase agreements. Six percent of these borrowers chose seller-financed mortgages, in which the buyer pays the seller installments and receives the deed up front. Five percent used land contracts, in which the seller transfers the deed once the buyer makes the final payment on the property. The most common alternative financing arrangement is the chattel loan, or personal property loan, which 11 percent of borrowers use despite the risks and costs. Karan Kaul, principal research associate at the Urban Institute, presented statistics on the use of chattel loans for purchasing manufactured homes, a low-cost housing option that, excluding the price of land, comes in at nearly one-third of the cost of site-built homes. The median mortgage interest rate for chattel loans in 2021, at 7.8 percent, was double that of manufactured home mortgages, and the median repayment term, at only 20 years, was shorter.
Kaul listed four reasons why chattel financing is so costly for borrowers. The industry is highly concentrated, with the top 10 lenders sharing 85 percent of chattel origination, and the lack of competition disincentivizes better lending terms. Furthermore, chattel loans are half the average loan size of manufactured home mortgages, so lenders charge chattel loan borrowers higher rates to compensate for the costs of providing the loan. The chattel loan excludes the land, forcing lenders to raise costs to account for losses on the depreciating structure. Finally, no government sponsored enterprises (GSEs) provide or guarantee chattel loans, leaving lenders without a mechanism for subsidizing their risk.
Michael Stegman, an Urban Institute nonresident fellow, discussed findings on lease-to-purchase agreements, which involve a rental period for the property followed by ownership. Unlike other alternative financing methods, lease-to-purchase arrangements are part of federally guaranteed markets, offering minorities a less risky pathway to homeownership. Stegman explained that households using lease-to-purchase financing can use on-time rental payments to build a credit history while also saving for a downpayment. Also, newer business models do not require households to purchase the home at a predetermined price; instead, lenders have implemented “buy-boxes” that place a lower and upper bound on the home prices. Despite these upsides of lease-to-purchase arrangements, Roche explains that the regulations governing these arrangements, like those of other alternative financing arrangements, vary by jurisdiction and can be ambiguous. Roche states that “even though few states have specific lease purchase laws, the rental part of that arrangement should typically fall under landlord/tenant law. But the option contract usually does not. And our research shows that in practice some landlords or sellers do not abide by the existing rental protections, even in states with laws. The reality is [that] sometimes borrowers are treated as tenants and sometimes as homeowners, and this makes their rights and responsibilities confusing.
Alternative Financing Policy Reform and the Racial Homeownership Gap
The research that Roche and Kaul presented shows that Hispanic, African-American, and low-income households disproportionately use alternative financing arrangements. According to the Pew Charitable Trusts survey, 23 percent of borrowers earning less than $50,000 annually chose an alternative financing arrangement. The survey also found that 23 percent of African-American home borrowers and 34 percent of Hispanic homebuyers have used alternative financing compared with just 19 percent of White home borrowers.
Although these statistics highlight the larger issue of many households’ inability to obtain small mortgages, the panelists agree that an expansion of federal policy and protections can focus on the alternative finance methods they are already using by making them safer and more feasible for minority wealth building. For lease-to-purchase agreements, Stegman recommends transparency and disclosure as a requirement to receive federal financing, including financial consequences for lenders that do not exercise their purchase option. This policy expansion would greatly serve minorities entering the lease-to-purchase industry, which Stegman says has the potential to increase homeownership for “2 million black Americans and 3.5 million Hispanic Americans that Freddie Mac estimates are in their homebuying prime and near-mortgage ready.” Sometimes federal support for alternative financing is simply better messaging. Epperson states that Freddie Mac recently clarified that borrowers can apply downpayment assistance toward a choice home loan for manufactured housing.
Policies have historically overlooked low-income and minority homebuyers, who are more likely to seek alternative financing because of barriers to accessing traditional mortgages. Despite the predatory practices and wealth-building hurdles, alternative financing options still serve as a pathway to affordable homeownership for some borrowers. Recent research highlights an opportunity for federal policy to support these financing arrangements by reducing risk to lenders and borrowers. The Federal Housing Finance Agency finalized the Duty to Serve 2022–2024 rule to better serve manufactured housing, and the GSEs released a joint request for more information to improve the chattel loan program through Title I lending. Evidence of more policy activity also includes the introduction of 70 manufactured housing bills, of which 13 passed, and the introduction of 12 alternative housing bills, of which 1 passed, according to the Pew Research Center. These policy actions are giving qualified homebuyers financial access to the affordable housing options available throughout the country.