Though the real estate market flourished in much of the country during the COVID-19 pandemic, buying a home is harder than ever for many families—particularly those looking to become first-time homeowners. Affordable, low-cost properties in urban, suburban, and rural communities still exist, but access to the small-dollar mortgages needed to finance them is not readily available. Potential homeowners not only find fewer lenders offering small-dollar mortgages, but once they do and they apply, we find they are more likely to be denied than potential homeowners applying for larger loans.

Our recent research found that only one in four low-cost homes sold was likely to be financed with a mortgage. In 2019, 26.7 percent of home sales nationwide were for homes priced below $100,000. Of those, only 23.2 percent were purchased with a mortgage, compared with 73.5 percent of homes priced at or above $100,000. (Past research documented the lack of availability for mortgages of $70,000 or less. Accounting for housing market appreciation, recent work adopts $100,000 as a small-dollar threshold.)  

The inaccessibility of small-dollar mortgage loans is a key barrier to homeownership for many families with low and moderate incomes, leaving them continuously rent burdened with few options for upward mobility and wealth building. In many US markets, households pay more for rent than the monthly user costs (principal, interest, taxes, and insurance) of owning a home. A recent report shows that in 40 percent of counties nationwide, buying a home was as or more affordable than renting. Black households are particularly affected, largely because of historical inequities that have limited their economic opportunities. Today, racial disparities in homeownership are wider than they were 1968 when the Fair Housing Act was passed, driving a growing racial wealth gap. In 2019, the median Black household held one-eighth the wealth of the median white household.

The Federal Housing Administration’s (FHA’s) mission is to provide mortgages to creditworthy borrowers who are underserved, but evidence suggests that FHA support for small-dollar mortgages needs improving. Leveraging our past and current work, we reexamine FHA direct lending in small-dollar mortgage loans, highlight how FHA loans are disproportionately denied to potential buyers, and call attention to responses to this problem. 

FHA direct lending in small-dollar loans doesn’t match the need

FHA mortgages are a vital option for first-time homeowners, especially for households with low incomes. First-time homebuyers accounted for more than 84 percent of all FHA mortgages in 2020. But FHA loans are not meeting the low-cost market need for less affluent homebuyers, and the small-dollar mortgages that are made primarily come through conventional financing channels. Compared with the FHA lending share for large loans, the FHA lending share for small-dollar purchase loans is lower for all low-income categories. Though the FHA is a key lending channel for first-time homebuyers, it underserves low-income borrowers with small-dollar loans.

Small-Dollar Lending, by Lending Channel and Borrower Income

Source: Home Mortgage Disclosure Act records.
Note: Based on purchase mortgage originations in 2019.

FHA denial rates for small-dollar loans are higher than for larger loans

One reason for the lack of small-dollar mortgages is that potential buyers of low-cost homes face higher mortgage denial rates. Previous Urban Institute research showed that denial rates for small-dollar mortgage loans are higher than for larger loans in both the government and conventional channels. Lack of creditworthiness is not the reason for the higher denial rates for small-dollar loans; instead, the lower return on investment for smaller mortgages does not provide incentives for government and conventional lenders to provide access to credit.

We looked again at the problem and, using 2019 Home Mortgage Disclosure Act data, find that this trend stays consistent. Applications for small-dollar mortgages (below $100,000) were significantly more likely to be denied than applications for larger loans (at least $100,000) in 2019.  

Federal responses

Recently, the Urban Institute and the Housing Council of America and Fahe partnered to test the viability of a small-dollar mortgage product designed to remove frictions that limit this type of lending. We launched a demonstration project in the Louisville, Kentucky, metropolitan area, where median rent can well exceed the monthly payment to own a home under $100,000 with a 30-year mortgage and where opportunity exists to increase homeownership in majority-Black neighborhoods. Insights from the initiative suggest the FHA could consider enhancements and improvements to help make small-dollar lending more accessible:

• Be flexible with underwriting.
• Provide homebuyer education.
• Reduce fees.
• Leverage lending channels that serve the target borrowers, such as community development financial institutions and community banks.
• Use automated valuation tools to reduce costs and potentially address the appraisal gap issues that arise in low-cost markets.

Several members of Congress have cosponsored legislation this session that cites Urban Institute research and directs the US Department of Housing and Urban Development (HUD) to review the effects of FHA single-family mortgage insurance policies, practices, and products on small-dollar mortgage lending. The legislation would require HUD to identify actions to remove barriers to supporting, facilitating, and making FHA insurance available for mortgages under $70,000. New research demonstrating the significant lack of access to credit for loans under $100,000 might inform the debate and demonstrate where the legislation could be updated to address the latest analysis. 

Amid an affordable housing crisis, small-dollar mortgages could be a lifeline for many prospective buyers. The FHA and federal government have a central role to play in breaking down and studying barriers to access. Increasing the accessibility of small-dollar mortgage loans can make homeownership a reality for families burdened with high rent payments and enable them to reap the benefits of one of America’s most important wealth-building mechanisms.  

The Urban Institute has the evidence to show what it will take to create a society where everyone has a fair shot at achieving their vision of success. 

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