Bank of America recently announced a new program that cuts the Federal Housing Administration (FHA) out of the mortgage lending equation with its latest mortgage product, dubbed the “Affordable Loan Solution.”
The new program will allow low- and moderate-income (LMI) borrowers to put a mere 3 percent down on conforming loans, and it will require no private mortgage insurance—regardless of the total amount of the loan.
Karan Kaul, Research Associate I at Urban Institute, recently made the argument that Bank of America's mortgage solution, while promising, is not a substitute for healthy FHA lending.
Kaul noted that the bank's program has been viewed by some as an "attempt to create a channel for lending to LMI borrowers that bypasses FHA and its heavy enforcement hammer." However, he says that "such efforts are an alternative to FHA lending, they are not a substitute, as the underlying economics of this deal make it difficult to scale up lending in a manner that would replace FHA."
Terry Francisco, VP of Corporate Communications at Bank of America, told DS News that the new program provides just such an alternative. In fact, Bank of America expects that three out of the four mortgages generated under the Affordable Loan Solution would have otherwise been backed by the FHA.
“This product that we’ve developed in partnership with Freddie Mac and with Self-Help Fund provides an effective alternative for FHA that’s somewhat less expensive, but also structured in a way that we believe will make people successful homeowners and will provide another option for people who are looking to become homeowners or people who could be moving up from one home to another,” Francisco said. “We think it adds more options for low- to moderate-income individuals to either attain homeownership for the first time or move up in the marketplace.”
Though it’s meant as a competitor to FHA, requirements for Bank of America’s program will be slightly different from the FHA’s. In in order to qualify for the program, borrowers will need a FICO credit score of at least 660, as well as a household income that’s less than the median income of the region. When significant credit history is lacking, Francisco said Bank of America will also consider “non-traditional forms of credit.”
“What we mean by that is if someone has a thin file, where they don’t have a lot of credit cards or other experience paying debts, if they paid rent on time or if they paid health memberships, cell phone bills—things like that—if they can that they’ve had a strong history of paying those bills on time, that’s acceptable as non-traditional credit,” Francisco said
Kaul said that in a market in which LMI borrowers have trouble getting a mortgage, Bank of America's Affordable Loan Solution "is a welcome effort to find a creative new channel through which many can finally obtain a mortgage."
However, it is important to note that this kind of channel is likely to be limited in scope, for several reasons, according to Kaul:
- The most significant barrier to larger-scale adoption of programs like this is the shortage of available capital. The ALS model relies solely on capital provided by Self-Help. Nonprofit capital is often sourced via loans or grants from foundations, community development organizations, or the government. Limited funding from these sources means the potential mortgage origination volume through such initiatives is also limited.
- The second likely barrier is that it will prove difficult for lenders using this type of execution to compete with FHA on price. The most borrower-friendly feature of the ALS mortgage is that PMI, which can cost several hundred dollars per month, is not required. It’s not clear, however, if ALS borrowers will be charged a higher mortgage rate in lieu of PMI. If they are, the potential for savings will be lower.
- Increasing the loan volume for ALS-like programs will also require lenders to offer much deeper savings to make these loans cheaper than FHA because GSE mortgages require riskier borrowers to pay higher fees, whereas FHA doesn’t.
"None of this is to criticize the program, which is a creative effort to improve access for a group of borrowers for whom credit is overly constrained," Kaul explained. "It is just a reminder to keep the effort in perspective. While programs like this are needed, they are unlikely to offer a substitute for a healthy market in FHA lending, in which lenders are willing to lend further down the credit spectrum to those who fit within FHA’s mission."