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March/April 2008

The Tarnished American Dream? A Prescription for Sustainable Homeownership in Wisconsin by John Keckhaver

From 1994 to 2004, the homeownership rate in Wisconsin rose from 64 percent to over 73 percent. This represents a dramatic increase historically, with profound implications for the many families and individuals moving into their own homes during those years. The homeownership rate has since fallen from that high, but has not declined as much as the national rate.

Homeownership has long been considered a key step toward financial security, with positive impacts for both the homeowner and the rest of the community. While there has been recent discussion of the need to further examine these long-held contentions—for example, to gather and analyze data by race and income level--it is still widely accepted that homeownership can do a world of good for families.

The impacts on children are especially promising, according to research from Harvard University’s Joint Center for Housing Studies. Homeownership leads to a better home environment, as defined by cognitive support/physical environment and the emotional support of children in the home. They have also linked owning a home to higher cognitive outcomes in both math and reading. There are also fewer behavioral problems for children in homeowner families as compared to families who rent their homes. The cognitive and behavioral impacts are also linked to higher educational achievement and greater future earnings. Research shows that even when controlling for parental economic, demographic and social characteristics, as well as the child’s gender and health, number of siblings and the household’s location, homeownership improves children’s cognition and reduces behavioral problems.(1)

These powerful impacts have led to efforts to increase homeownership through public policy. Myriad financial benefits are available to those who own their homes. Tax benefits, for example, including the mortgage interest deduction, total over $60 billion per year nationally.

Despite growing economic uncertainty in recent years – with wages stagnating for many workers, growing family debt levels, and an unpredictable labor market – high homeownership rates were touted by many, including President Bush, as evidence that most if not all was well with the economy and that families were thriving. Then the housing bubble burst.

While debate will linger about how much blame to assign to whom, there were clearly a number of factors that contributed to our current housing market mess. Housing prices had increased dramatically for a number of years. The work of appraisers and their relationships to lenders have been called into question, with evidence of strong pressure to “hit the number” in order to make a transaction occur. The exuberance over rising home prices resulted in residential housing in many markets being used as a short-term investment, thereby pushing up prices even further.

In order to buy into this market, many borrowers turned to increasingly available nontraditional loans, which often included no down payment and low initial “teaser” interest rates. For those with poor credit – subprime borrowers – loans with these terms were particularly enticing. Adjustable rate mortgages (ARMs), which start out at a low interest rate that then rises periodically, were especially attractive. Research has shown that minorities, even when qualifying for prime loans, were disproportionately offered nontraditional subprime loans.

When interest rates rose, which they were bound to do, many homeowners found themselves with monthly payments increasing by $500 or more. Foreclosures then started to increase, adding even more homes to an already overbuilt housing market. As foreclosures increased and lenders (as well as the many financial firms that purchase loan debt) started taking losses, lending practices finally tightened up. One result of this tightening, however, has been that refinancing to more stable, fixed-interest loans has became difficult for many households at or near the foreclosure stage because they do not qualify under the new, tougher standards.

Unfortunately, the worst of the housing collapse is not over. Thousands of adjustable rate mortgages in Wisconsin will have their interest rates reset in 2008. Nationally, more people are in the foreclosure process right now than at any other time in the last 36 years in which this was measured (2.04 percent of all mortgages or 900,000 households). Another 380,000 households are about to enter the foreclosure process. The number of those over 30 days late on their mortgage payments is at its highest rate since 1985. Subprime borrowers have been under the most pressure, with a foreclosure rate of 5.29 percent (up from 2.70 percent a year ago).

While the foreclosure rate in Wisconsin is not as high as the national figure, foreclosures here continue to increase faster than the national pace. And with the nation facing a recession and employment levels dropping off, our residents face a dire overall financial picture.

So what’s the prescription?

The housing crisis will not wane for some time, but now is a good time to minimize the damage, examine in greater detail the forces that got us here, and to take steps to ensure that when we so get back on a positive homeownership track in Wisconsin, it’s a sustainable one. The following four steps could help us do just that.

Efforts have been made by some banks and through a federal effort called the Project Hope Now Alliance to help some homeowners facing foreclosure refinance to more stable loans. A number of states, however, went much further, and did so sooner, saving thousands of homes from foreclosure in the process. These states, often working with large financial institutions, offered mortgages to homeowners, then sold the loans to government-backed mortgage lenders like Freddie Mac and Fannie Mae, using the proceeds from the sales to offer more refinancings. Wisconsin could adopt a similar approach. With housing prices dropping at the same time in which many households carry high home equity line of credit debt levels, it will be difficult for some homeowners to refinance at this time, but many will certainly qualify.

A 2004 law that regulates licensed mortgage lenders in Wisconsin could be strengthened in the following ways:

3. Improve loan term clarity and borrower knowledge.

Illinois recently instituted a mortgage/financial literacy training for certain borrowers about to take out a nontraditional loan. While this step is a positive one, and could be adopted here in Wisconsin, there are other options for ensuring that lenders are clear about the terms of loans and borrowers understand them. A recent bill in Wisconsin, SB 352, would have required lenders to include clear disclosure of loan terms on a single-page document, both at the time of application and at closing. This simple step, entailing very little administrative burden on lenders, would ensure clarity and would also protect consumers against last minute loan changes as well as outright fraud.

The independence of a key player in the housing and lending system – real estate appraisers – has been called into question in the current crisis. In order to ensure that real estate appraisers are truly independent and acting as neutral parties in their appraisals, a thorough examination should be conducted of their practices, the role they have played in the current crisis, and how their independence could be assured.

Homeownership brings children and families significant advantages when the buyer can afford the home. If we do not thoroughly examine and come to understand the forces that produced the current housing and credit crisis, we will be inviting recurrences down the road. The four steps outlined above would help current homeowners who find themselves on the brink of foreclosure, and would help put the state back on track toward increasing homeownership rates that are sustainable.