Shrinking availability of ‘small-dollar’ mortgages hurts low-income home buyers

In Philadelphia, about a third of owner-occupied homes were valued at less than $125,000 in 2021. But that year, only about 2% of mortgages made in the city were the type generally used to purchase properties in this segment of the market, according to an analysis by the Federal Reserve Bank of Philadelphia.

Mortgages valued at $100,000 or less — referred to as small-dollar mortgages by the Philadelphia Fed — can help aspiring homeowners with lower incomes access properties they can afford. But lenders made fewer of them between 2019 and 2021, according to the Philadelphia Fed’s report, released recently.

Researchers examined federal mortgage data to examine the small-dollar mortgage landscape in the region.

Why small-dollar mortgages are worth attention

The majority of borrowers who receive small-dollar mortgages in Pennsylvania — 75% — and New Jersey — 81% — have low or moderate incomes. These borrowers had median incomes of $42,000 in Pennsylvania and $47,000 in New Jersey.

“Small-dollar mortgages can help people with limited income or savings to purchase lower cost homes” and become homeowners when they otherwise couldn’t afford to do so, said Kyle DeMaria, coauthor of the report and a community development research associate at the Philadelphia Fed.

Home ownership remains the way most Americans build wealth.

Serving low- and moderate-income borrowers also helps lenders fulfill obligations under the federal Community Reinvestment Act, which is meant to ensure lenders meet the needs of their communities.

Small-dollar mortgage lending is declining

Between 2019 and 2021, the number of small-dollar mortgages dropped by 28% in Pennsylvania and 43% in New Jersey, according to the Philadelphia Fed. In 2021, 8% of purchase mortgages in Pennsylvania — about 12,000 loans — and 1% of purchase loans in New Jersey — about 1,400 loans — were $100,000 or less.

Some of the decline is tied to the rise in home prices during the past few years, spurred by high housing demand and low supply. Small-dollar loans don’t go as far as they used to.

Another trend that might help explain the decline in small-dollar mortgages was the uptick in investment purchases. Investors tend to use cash, not mortgages, to buy homes that cost $100,000 or less.

And generally within the lending industry, the higher the value of a loan, the more money a lender can collect in fees. So the system incentivizes making larger loans and discourages making smaller loans.

When home buyers can’t get small-dollar mortgages, they could turn to riskier or more expensive alternatives, such as rent-to-own agreements.

Small-dollar mortgage borrowers face higher denial rates

In Pennsylvania and New Jersey, applicants for small-dollar mortgages are twice as likely as borrowers overall to be denied. Borrowers trying to get smaller loans also are more likely to be denied because of credit history, according to the report.

Lenders use credit scores to help predict a borrower’s risk of defaulting on a loan. But recent research has shown that credit scores are not as good at predicting risk for people of color or borrowers with lower incomes as they are for white borrowers or those with higher incomes. One reason is that applicants of color and those with lower incomes disproportionately have shorter or nonexistent credit histories.

This year, the government-sponsored enterprises Fannie Mae and Freddie Mac began allowing lenders to take into account home buyers’ on-time and consistent payment of rent when making lending decisions for government-backed loans. Considering this kind of information “may help to close some of the disparities we see in denial rates for mortgages,” DeMaria said.

“Alongside strategies to minimize lender origination costs,” wrote DeMaria and coauthor Emily Goldstein, a former Philadelphia Fed intern, in their report, “these efforts could expand access to small-dollar mortgages and affordable homeownership opportunities for low- and moderate-income borrowers.”