It was a common, but very quiet practice years ago for lenders and some insurance providers to "redline' certain areas or neighborhoods. They wouldn't write mortgages or home insurance policies in certain parts of town they considered "in decline." The end result - these neighborhoods would decline even further, as many buyers wanting to move into these neighborhoods had little or no financing or insurance options here.
Today, Countrywide Home Loans, and several other lenders, are applying "Soft Market' or similar proprietary scores against some locations they feel show a pattern of declining property values, housing oversupply, or extended market times. Click here for Countrywide's Soft Market Index Rankings for across the U.S.
Here in Chicago, the entire Metropolitan Area has been scored a "2" on Countrywide's 1-5 scale (with 5 indicating those areas in greatest value decline). At lender's discretion, Countrywide customers here may be penalized with an additional 5% down payment requirement if the appraiser identifies the local market around a subject property in "oversupply," or has average market times over 180 days.
GMAC applies a similar scoring model - as does Fannie Mae, for loans that originated after January 15th.
Critics abound on this point, many saying the scoring process creates a self-fulfilling prophecy of declining values in neighborhoods adversely scored, and could be considered discriminatory. Brian Robinett, of Countrywide Home Loans, defends his company's new practice, saying it equally affects all property types, household income levels, and ethnic groups on an equal basis.
For more details, please review our posting today on the Dean's Team Chicago Blog Center - BlogChicagoHomes.com. Also, read Kenneth R. Harney's article in the Sunday, Feburary 3rd edition of the Chicago Tribune.
DEAN & DEAN'S TEAM CHICAGO
Just to play devil's advocate for a moment...on one hand, politicians, eager to score points with their constituencies, complain that lenders are unfairly "redlining" certain neighborhoods. They bully companies into writing subprime loans in high-risk neighborhoods, then accuse those same companies of predatory lending practices when the loans go bad.
One man's "redlining" is another man's good business practice. Seems to me that these lenders are damned if they do and damned if they don't.
Dean
Long problem solving day. I will call you mid day
Thanks
Tommy
Hi there,
Good info, but I don't think I'd agree with Mr. Robinett's explanation. It will be interesting to see how this plays out, guess time will tell.
Dean,
Being in an area 5 zone, I am seeing this in Arizona everyday. Great Post
Very good information. I have not seen this before.
Thank you
Just FYI. If you are having issues with these areas and getting your buyers loans reduced due to "soft markets" FHA / VA does not have the "soft market" restrictions applicable..... YET!
Dean -- Great topic. I've seen this going on for quite awhile with several lenders. Just not as blatantly.
Russ -- Is not writing loans below $40k-$50k really redlining? I thought that had more to do with not violating Section 32 guidelines.
Don't be so quick to blame the lenders for issues like this. Countrywide, and other lenders, are only following the directives of investors. And policies like "soft market" only prove the lack of confidence investors have in real estate right now. Needless to say, it will change over time and policies like these will be revised back to the way they were. In the meantime, look to FHA for your low downpayment buyers.
Everyone -
Thanks for thoughtful comments!
The bottom line here - the practice of the "Soft Market Index" is a gray area - potentially discriminatory, or just a business-risk decision. For years, insurance companies have looked at zip code claims history for auto and home insurance - then apply a discount to you for being a "good driver" or a homeowner without claims.
The problem here - it can possibly scuttle deals in progress, or encourage those that get rejected for their desired down payment to seek out some lending source - any lending source - that will provide the terms they are looking for.
I feel the county-wide, or, in some cases, zip-code-wide, scoring, paints the market with too broad a brush. Especially, here in Chicago, where parts of the metro area are very vibrant and in growth mode, other neighborhoods are experiencing severe oversupply.
In their zeal to tighten things up, Countrywide may be throwing out the baby with the bath water, and exasperating the problem.
DEAN & DEAN'S TEAM CHICAGO
This is not a Countywide guideline but a Fannie Mae guideline. https://www.efanniemae.com/sf/guides/ssg/relatedsellinginfo/pdf/declmktsmaxfinfaq.pdf
Here in Las Vegas, where we are a Level 5, every bank except one who is only lending portfolio is enforcing it.
In New York, FEMA just recently revised the flood Zone in one coastal area. The result was buyers are now required to purchase flood insurance- which is a costly undertaking. Will it affect sales? Of course it will.
Very well written post!
Very timely post, as we just talked about this in my management meeting on Monday. It is going to be troublesome for sure in my hard-hit Toledo, OH market, plus we are also being hit with the new FEMA flood maps by year's end, putting a majority of the Toledo area in the predicament of needing flood insurance. Crazy, since most of these areas never, ever flood.
As an added bit of advice, a way to facilitate a transaction that is flagged by an appraiser as being in a soft area, is to use FHA as the route of financing. Or so my in-house lender tells me, who is great at FHA loans (we have a joint venture with Wells Fargo). Feel free to email me if you want more info on this, as I am not a lender and may need more details from her.
Dee
THE REAL SCANDAL
HOW FEDS INVITED THE MORTGAGE MESS
By STAN LIEBOWITZ
February 5, 2008 — PERHAPS the greatest scandal of the mortgage crisis is that it is a direct result of an intentional loosening of underwriting standards - done in the name of ending discrimination, despite warnings that it could lead to wide-scale defaults.
At the crisis’ core are loans that were made with virtually nonexistent underwriting standards - no verification of income or assets; little consideration of the applicant’s ability to make payments; no down payment.
Most people instinctively understand that such loans are likely to be unsound. But how did the heavily-regulated banking industry end up able to engage in such foolishness?
From the current hand-wringing, you’d think that the banks came up with the idea of looser underwriting standards on their own, with regulators just asleep on the job. In fact, it was the regulators who relaxed these standards - at the behest of community groups and “progressive” political forces.
In the 1980s, groups such as the activists at ACORN began pushing charges of “redlining” - claims that banks discriminated against minorities in mortgage lending. In 1989, sympathetic members of Congress got the Home Mortgage Disclosure Act amended to force banks to collect racial data on mortgage applicants; this allowed various studies to be ginned up that seemed to validate the original accusation.
In fact, minority mortgage applications were rejected more frequently than other applications - but the overwhelming reason wasn’t racial discrimination, but simply that minorities tend to have weaker finances.
Yet a “landmark” 1992 study from the Boston Fed concluded that mortgage-lending discrimination was systemic.
That study was tremendously flawed - a colleague and I later showed that the data it had used contained thousands of egregious typos, such as loans with negative interest rates. Our study found no evidence of discrimination.
Yet the political agenda triumphed - with the president of the Boston Fed saying no new studies were needed, and the US comptroller of the currency seconding the motion.
No sooner had the ink dried on its discrimination study than the Boston Fed, clearly speaking for the entire Fed, produced a manual for mortgage lenders stating that: “discrimination may be observed when a lender’s underwriting policies contain arbitrary or outdated criteria that effectively disqualify many urban or lower-income minority applicants.”
Some of these “outdated” criteria included the size of the mortgage payment relative to income, credit history, savings history and income verification. Instead, the Boston Fed ruled that participation in a credit-counseling program should be taken as evidence of an applicant’s ability to manage debt.
Sound crazy? You bet. Those “outdated” standards existed to limit defaults. But bank regulators required the loosened underwriting standards, with approval by politicians and the chattering class. A 1995 strengthening of the Community Reinvestment Act required banks to find ways to provide mortgages to their poorer communities. It also let community activists intervene at yearly bank reviews, shaking the banks down for large pots of money.
Banks that got poor reviews were punished; some saw their merger plans frustrated; others faced direct legal challenges by the Justice Department.
Flexible lending programs expanded even though they had higher default rates than loans with traditional standards. On the Web, you can still find CRA loans available via ACORN with “100 percent financing . . . no credit scores . . . undocumented income . . . even if you don’t report it on your tax returns.” Credit counseling is required, of course.
Ironically, an enthusiastic Fannie Mae Foundation report singled out one paragon of nondiscriminatory lending, which worked with community activists and followed “the most flexible underwriting criteria permitted.” That lender’s $1 billion commitment to low-income loans in 1992 had grown to $80 billion by 1999 and $600 billion by early 2003.
Who was that virtuous lender? Why - Countrywide, the nation’s largest mortgage lender, recently in the headlines as it hurtled toward bankruptcy.
In an earlier newspaper story extolling the virtues of relaxed underwriting standards, Countrywide’s chief executive bragged that, to approve minority applications that would otherwise be rejected “lenders have had to stretch the rules a bit.” He’s not bragging now.
For years, rising house prices hid the default problems since quick refinances were possible. But now that house prices have stopped rising, we can clearly see the damage caused by relaxed lending standards.
This damage was quite predictable: “After the warm and fuzzy glow of ‘flexible underwriting standards’ has worn off, we may discover that they are nothing more than standards that lead to bad loans . . . these policies will have done a disservice to their putative beneficiaries if . . . they are dispossessed from their homes.” I wrote that, with Ted Day, in a 1998 academic article.
Sadly, we were spitting into the wind.
These days, everyone claims to favor strong lending standards. What about all those self-righteous newspapers, politicians and regulators who were intent on loosening lending standards?
As you might expect, they are now self-righteously blaming those, such as Countrywide, who did what they were told.
Stan Liebowitz is the Ashbel Smith professor of Economics in the Business School at the University of Texas at Dallas.
This needs to be shouted from the (foreclosed) rooftops.
But of course it will not be.
(And of course not only is Mrs. Clinton a big ACORN supporter, but Mr. Obama worked for them both before and after attending law school.)
Redlining is still alive and well. They added a new twist here in Los Angeles. The idea here is to reduce the appraisals by 10% to 15% and then offer the same LTV, which in most cases are deal killers as the loan becomes short to close or it won't allow enough cash out to satisfy the borrower.
This has be happening in many parts of South Central LA for more than 5 years. Funny part is that you can show them comp after comp and they won't change the value. Same old illegal practice with a new wrinkle.
Countrywide, Argent and New Century were major players using their review appraisal authority. South Central addresses would always fall out of the AVM system and require a desk review, resulting in a reduced value.
Credit scoring is a form of red lining after all you can make your payments on time but if the matrix does not like how you use it (your revolving credit for example) they reduce your score.
Naturally in economically depressed areas scores have tendencies to be lower that's the reason some of the subprime popped up to begin with and some of the programs were and are great programs but they don't exist anymore.
Red lining is an odd concept to me anyway. If it is profitable, and the normal risk analysis is done to support the loan resulting in a profit then banks will make the loan. It is about the green in the end.
Kirk,
Very good point. I've always believed that if I was an attorney, I would take up a case of credit scoring and true believe it can be found to be a discriminating factor.
I believe it would not hold to a court challenge from a competent attorney. Trust me if you pursued a serious challenge of this icon, there will be lot of haters that will seek to defeat you.
As long as people are human, we'll always have these challenges as some seek to take advantage of others or deny others of benefits they deserve.
Greed! Greed! Greed!
These cats know their business. Perception is reality. Consequently, a stratified portfolio would not look good appealing with properties in certain localities. To exclude then you REDLINE or create a way that don't look on the surface to appear illegal but in reality is REDLINING.
Morality can never be legislated.
Ntsike WIllis -- don't chalk everything up to cartoonish evil motives. It would be extraordinarily stupid for a business to lend money *without* calculating the risk. That is simply the technical term for "how likely is it that we will get paid back". That is a good thing for a business to estimate. There is nothing immoral about this -- the employees are not lending their own money, they are lending other people's money.
Second, redlining is merely an easy to follow (for the employees) rule to avoid mistakes. If an area is in decline, there could still be some reasonable loan terms, but loans there are riskier -- they are more likely to lose that someone else's money. Redlining is a simple control that allows the company to say "we've looked at this area and don't want to risk it". Businesses don't need to make every possible sale/loan/contract possible -- they make those that can be made without too much hassle and risk. Also, making reasonable loans in the redlined areas would require doing so with higher rates, causing some people who don't understand the situation to howl with rage. It's not worth that risk either oftentimes.
More importantly, why is it morally better to lend people money to buy houses that professionals believe are going to lose value?
I notice you use the word "deserve", but I find that hard to defend. Do people "deserve" to use other's money to buy themselves things? Hardly -- people only lend money to be paid back, along with some interest for the risk and trouble. They don't lend because someone deserves something. Do people "deserve" to borrow money to buy something that is going to lose value? Do they "deserve" to borrow money they can't pay back. I think the answer to all of these is "no". Not because I'm some mean person who tries to take advantage of others. Don't paint your world in such bleak colors.
People watching out for themselves is not a bad thing. Do you get in your car with the intent to drive into a tree? No? Are you some kind of greedy person who is watching out for themselves? Do you buy a new TV with the intention of throwing it out the window? No? Of course not and you should't. These things not beneficial to you.
I'm not saying that you shouldn't do things for other people. I'm sure you do. I do also. But you shouldn't be forced to lend your money to people you don't think will pay it back.