High origination and servicing costs make smaller loans less attractive
Lenders are denying small-dollar mortgages for single-family purchases at higher rates than larger loans in spite of borrower creditworthiness, an analysis by the Urban Institute has found.
As a result, families who are creditworthy find themselves limited when finding affordable homeownership opportunities in low-cost housing markets. The Urban Institute found that in 2015, only a quarter of homes that sold for $70,000 or less were financed with a mortgage, compared to almost 80% of homes valued between $70,000 and $150,000.
The Urban Institute found that the applicants’ creditworthiness has no effect on the higher denial rates for small-dollar mortgages.
The analysis looked at the 2017 observed denial rate, which is the traditional measure, and found that 18% of mortgage applications for small-dollar mortgages up to $70,000 were denied. The rate was double that for large loans of more than $150,000.
Finding that the observed rate did not explain the difference in denial rates, the Urban Institute developed the real denial rate (RDR). As the RDR can control for differences in creditworthiness, it allows for better understanding of the role of creditworthiness in the higher denial rates of smaller loans.
The Urban Institute said that the RDR revealed that the creditworthiness of applicants for smaller loans is not the basis for the higher denial rate of these loans.
The analysis found that little variation in applicants’ credit profiles by loan size. The Urban Institute found that 34% of the applicants for small-dollar loans had low-credit profiles. This compared to 35% for loans between $70,000 and $150,000, and 30% for loans more than $150,000.
After controlling for applicant credit profiles, the Urban Institute still found a significant gap in denial rates between loan sizes, varying from 29% to 52%.
The study called for further research on creative solutions to better serve the small-dollar mortgage sector, noting that the high fixed costs of originating and servicing a loan make smaller loans less attractive to lenders.