Unaffordable mortgages are a major problem facing low-income households, but the tough loans are also exacerbating other financial problems they suffer.
Some markets fare much better than others, but on average, one out of every three low-income borrower falls behind on bill payments in a typical year, one out of every four now pays more than 40 percent of their income on debt payments and the total debt held by low-income households has soared by 308 percent during the last 15 years.
Given the last housing boom's push to increase homeownership among lower income borrowers, it's not surprising most of their financial burdens stem from mortgages they can't afford, according to a new Brookings Institution Metropolitan Policy Program study "Borrowing to Get Ahead and Behind: The Credit Boom and Bust in Lower-Income Markets".
For many of these households, the quest for the American Dream may have been too much too soon and their chances for homeownership may be lost forever or at least in the near future.
Brookings' findings are based on the data of 3,803 households in 1989 and 4,522 households in 2004, and in both cases the data was gleaned from the Federal Reserve's Survey of Consumer Finances. The report also used credit information from 14.1 million anonymous TransUnion credit reports.
The study found:
- More than 55 percent of lower-income households held debt in 2004, up 10 percent from the level in 1989. Total debt held by these households during the period increased 308 percent and now totals $481 billion, up from $181 billion.
Most of this debt is for mortgages and related borrowing.
- The mortgage use rate among lower income borrowers grew by nearly 46 percent between 1989 and 2004, but rose only 18 percent for lower-middle income households, 15 percent for the upper-middle income group and 5 percent for high income households.
The growth reflects the benefits of regulatory and market changes during the period, but also raises questions about many lower income household's readiness for home ownership.
- More than 32 percent of lower-income borrowers struggle to pay bills on time; about 27 percent are highly leveraged and now spend more than 40 percent of their income servicing debt.
Along with a growth in mortgage debt, lower income households are also carrying greater, more expensive credit card debt. Credit card debt use grew by 42 percent during the same period.
- Credit use in lower-income markets varies widely by region. In Boston, 75 percent of borrowers owned money, but in Las Vegas less than 40 percent did.
The study found that lower-income market credit use increases when credit scores rise, when divorce rates and the proportion of immigrants decreases, and when the proportion of seniors increases.
The study also said total debt increases with rising credit scores of borrowers in lower-income markets, when the proportion of the uninsured and immigrants increases, and when mortgage lending policy becomes more stringent. The highest levels of indebtedness are also found in the areas of the country with the lowest costs of living.
- Credit management in lower-income markets also varies widely, from a low in San Jose, where less than 5 percent of borrowers in lower-income markets were behind on debt payments in 2005, to a high in Memphis, where more than 18 percent were delinquent on at least one bill.
Delinquency rates in lower-income markets increase as unemployment rates increase, and when the proportion of borrowers without health insurance increases. Surprisingly, the highest delinquency rates in lower-income markets are also in the least expensive areas in the country.
- When it comes to credit scores in lower-income markets, higher scores are associated with increases in credit usage, decreases in delinquency and unemployment rates, and decreases in the proportion of non-white borrowers.
Based on an evaluation of credit scores, potential growth in the supply of credit in lower-income markets varied from a low in Memphis and Milwaukee, where the average credit score in lower-income markets was 556 in 2005, to a high in Portland and San Jose, where the average score was over 635.
But this may be putting the carriage before the horse. Rather than the traditional focus on the supply of credit, lenders should have been more concerned with consumers ability to choose from a host of new credit products.
A recent National Foundation for Credit Counseling (NFCC) survey found consumers universally ignore the fundamentals of sound financial management, such as budgeting and tracking expenses, ordering free credit reports, and managing debt.
In another study by Bankrate, Inc. researchers found 34 percent of home owners do not know what type of mortgage they own. The study also said 34 percent of homeowners with adjustable rate mortgages (ARMs) do not know what they will do when their loan readjusts.
"The situation facing consumers is made even more difficult by the widespread use of targeted incentives that encourage some mortgage brokers and loan officers to aggressively market confusing, and often more costly, subprime products to less than knowledgeable and often desperate borrowers, says Nicolas P. Retsinas, director of Harvard University's Joint Center for Housing.
Funded by a Ford Foundation grant, the center produced two landmark reports, one discussing mortgage consumers' habits ("Understanding Mortgage Market Behavior: Creating Good Mortgage Options for all Americans"), the other, at times, a scathing review of mortgage industry practices ("Mortgage Market Channels And Fair Lending: An Analysis Of HMDA Data").
The Brookings report advices "Now, policymakers must also be concerned with the ability of consumers to choose from myriad different credit products … yet, policymakers need to proceed cautiously with these recommendations so as to address markets with apparent problems, while preventing disruption to markets without serious problems."
