Upper Income African-Americans Moving into FHA Loans

More home buyers are seeking mortgage loans backed by FHA guarantees.

I have been looking at lending patterns in my own community – Durham, North Carolina – and the 2009 numbers paint an interesting picture that suggests a dual marketplace. One group – white and Asian borrowers – continues to eschew the FHA program in favor of conventional loans. Another, made up almost entirely of African-American borrowers, is turning to the FHA program. What is more interesting is the extent to which the sudden switch is unaffected by borrower income. Even well-off African-Americans are flocking to FHA.

I ran a chi-square that sorted borrowers by their race or ethnicity and by their incomes. Incomes were separated into four ordinal categories: low, moderate, middle, and upper income.  Then I counted the number of loans made by owner-occupants in each group on single-family residential properties. The nifty thing about a chi-square is that it allows you to compare what a perfectly even distribution of lending activity would like with the actual outcome.

Without that, there are some problems. For one, buyers are not evenly distributed across the four income groupings. It turns out that Durham has a u-shaped income distribution.

This chart shows the inequality in the distribution of income among home buyers in Durham, North Carolina in 2009.

There are a lot of buyers on the two ends of the spectrum, but fewer in the middle. Durham has a relatively affordable housing stock. There are a lot of three bedrooms homes available for less than $150,000.

FHA made up about 20 percent of the mortgage market in Durham in 2009. It appeals to a lot of buyers because it has a much lower down payment requirement. At the same time, FHA loans include a premium payment that indirectly insures the mortgage. The end result is that the origination of an FHA loan often comes with higher transaction fees.

There is also the same skin in the game question. Many people say that at least part of the reason for why we got into so much trouble was because lenders were making loans without any fear of the consequences. They were able to move the loans off to the secondary market.

Today, the private securitization market has dried up. Fannie and Freddie buy the majority of new loans. They’ve imposed higher standards, and they are also adding new fees for the origination of loans. The loan-level pricing adjustments can easily add between 2 and 5 percent to the cost of a mortgage.

All of that helped to drive more borrowers to FHA in 2009. Things have changed since then. FHA has increased premiums on their own loans. That has pushed more loans back into the conventional space.

I wanted to emphasize the dynamic played by borrower race in this shift to FHA. The next table shows the ratio between how many loans should have gone to FHA and how many actually went to FHA. When the number is greater than one, it means that more borrowers used FHA in that category.

African-American borrowers use FHA products at a rate disproportionate to their makeup within the sum of homebuyers. That propinquity is consistent for both low-income and upper-income African-Americans.

Let me highlight several of these numbers.First, you can see that all three groups have a higher-than would be expected exposure to FHA. That doesn’t reflect the role of Asian-Americans. This group is always in the under-utilizing category. For African-Americans, the 1.4 number says actual FHA lending is 140 percent of the volume that would constitute the share predicted by their percentage of the population.

More interesting to me is the story of upper-income African-Americans. These borrowers used FHA at a rate that was more than twice what should have been expected. The pickup rate for FHA is generally lower for upper income borrowers. Presumably, that difference reflects the linkage between income and assets. More assets should translate into more ability to make a twenty percent down payment, which has been the minimum for at least the last year for a conventional loan.

The income-asset linkage is likely to be less powerful among African-Americans. These numbers reflect that distinction.

These numbers show that the FHA program serves African-Americans. What remains to be determined is if this is a problem or not. FHA is designed to help people hurdle over barriers into homeownership. That is an important goal. At the same time, the low downpayment feature creates its own problems. Borrowers are more exposed to the risk of ending up underwater. They are going to have higher monthly payments. As well, though the interest rate might be the same, the APRs usually end up a little higher in FHA.