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Affordable Housing, Decent Housing, Uncategorized

Are micro-mortgages back on the agenda?

I have been having conversations recently in India and elsewhere with people who believe that micro-mortgages are the next wave in housing finance.  I am glad to hear it, since access to mortgage finance is one of the things that divides the haves from the have-nots.  But it won’t be easy or risk-free as the US experience has shown (for a little refresher on the dangers, see this article from the New York Times).  Coming from a mortgage banking background, I have given this topic a lot of thought and I see three key issues that will have to be resolved before micro-mortgages can become a widespread reality: the cost of homes; providing mortgage security; and savings.

Cost of homes is right now probably the largest impediment to the growth of micro-mortgages. As an example, the Global Housing Foundation, which provides micro-mortgages, estimates that homes for the poor which meet minimum standards cost between $5,500 and $20,000 depending on the country.  Using their estimate of poor families earning a minimum of $35 per week, and assuming 25% of income can go to repay home loans, that family would be paying on their home for over 10 years.  If the cost of that home could be brought down to $1,000 the loan could be paid off in about 3 years. The good news is that there are exciting efforts to bring down the cost of homes for poor families.  I really like the $300 House Challenge, Tata’s Nano House, and Habitat for Humanity Nepal’s Bamboo House.  I would argue that these efforts, and others like them, to dramatically decrease the cost of a home, will make more homes affordable for poor families than any other intervention.  This, in turn, makes micro-mortgages a real possibility on a large scale.

Mortgage Security is another basic issue that is a major impediment for micro-mortgages.  As UN-Habitat points out in their Global Campaign for Secure Tenure…security of tenure is one of the most important catalysts for attracting large scale capital necessary for comprehensive slum-upgrading but also for the urban poor themselves to invest in their own dwelling and communities“.  Most low income people that could consider a micro-mortgage are using some sort of microfinance institution that specializes in unsecured loans.  I don’t think there is sufficient recognition of the difference between secured and unsecured loans in the low income finance community (nearly all microfinance is unsecured, and nearly all mortgage finance is secured).   Thus, even if the cost of the home is brought down to a level that makes micro-mortgages possible, microfinance institutions will have a steep learning curve before they are able to offer micro-mortgages at scale.  I am not really convinced that many microfinance institutions will even want to offer micro-mortgages.  Most of those I have spoken with see the home loan as an additional product rather than a replacement for the traditional microenterprise loan (the customer will still need funding for her business even as she builds or purchases a house).  This will push most borrowers into the red zone of debt burden unless the loan term is adjusted out (so in our example above, the borrower could repay in 3 years, but the MFI may adjust to  6 years and reduce the payment).  The problem is that a longer term unsecured loan for low income populations is more risky for both borrower (who may not be operating under a 6 year time horizon) and the lender (who may not have sources of funding for 6 year loans).  Securing the loan with a mortgage reduces the risk.

Savings is the third area that impedes micro-mortgages.  Again, we can look to the experience of the real estate bubble in North America where banks were lending the full value of the property.  They got burned when those values dropped.  Homeowners suddenly realized the banks had more to lose than they did, and walked away from their homes and debt obligations.  Granted, that bubble was fueled by lots of complicated and exotic financial instruments, but there is no question banks would have have been in a better position if borrowers had more of their own savings at stake.  Likewise, micro-mortgages will be more successful if they are built on homeowner savings.  The challenge is how to provide incentives for people to save more, and more quickly, for housing including down payment for micro-mortgages.  A recent finding from the ILO’s Microinsurance Innovation Facility reinforces other research showing that simply reminding people to save can result in substantial increases (up to 51% in the ILO’s study).  Other posts on this blog, for example here, provide more examples.

I think micro-mortgages hold tremendous potential for helping low income families build assets and live better.  I hope those working on the issues of housing cost, land tenure and title, and savings see that their work could be leveraged through these instruments.

 

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Discussion

4 thoughts on “Are micro-mortgages back on the agenda?

  1. Hey Patrick, good post. I agree in many ways around the promise of micro-mortgages.

    I don’t know that mortgages for the poor have ever been off-agenda though. If you look at the bi-annual World Bank conference on housing finance or the Wharton Course for international housing finance, for example, mortgage finance tends to dominate. Additionally, if you look at what bi-lateral donors and DFIs are funding around housing/urban development (an already small pot) it tends to be real-estate development/mortgage type work. Stuff like this: http://yaleglobal.yale.edu/content/africa-mortgages-boost-emerging-middle-class

    So, when looking at that universe, it seems that the arguments for (1) incremental housing (2) “tenure not title” and (3) the seeking of new delivery channels for shelter related investments (such as cement companies, microfinance institutions, or village savings groups) to be by comparison still fresh. Actually, a response in the NYT about the $300 house, had some strong arguments about the importance of more humbly enabling households to improve their homes incrementally: http://www.nytimes.com/2011/06/01/opinion/01srivastava.html

    Nevertheless, the micro-mortgage does remain something we should pursue. And it seems that middle income markets with emerging middle classes and maturing real estate markets are where the opportunity exists. So, naturally, India is a place you should be excited about their potential.

    But, I’d add to the challenges you list above the issue of transaction costs. I remember being with a colleague when we approached a relatively open-minded bank in a developing country about mortgages for a new development of “core houses” that were to cost about $2,500. We were very optimistic because many of the known problems for micro-mortgages had been overcome – (1) affordable house? Check! (2) clean title (with reasonable assurance by the bank for them to re-possess and re-sell – that is often overlooked) Check! However, the bank balked at the idea, because they estimated that the up-front processing and administration of each mortgage they underwrote cost them about $1,000. So, the idea of them spending $1,000 to underwrite a $2,500 transaction was infeasible. So, transaction cost, legal costs, and the underwriting processing of a lien-based securitized transaction, will likely be problematic for micro-mortgages, in the same way motorcycle gas and remote branch costs are for microfinance.

    The other idea that worries me is household risk. I’d suggest that mortgaged lending to the poor shifts risk to the household. A family unable to repay an unsecured microfinance loan (taken to repair a roof – for example) may lead to reduced future credit options. Default on a mortgage leads to the loss of a home and maybe homelessness. As the U.S. learned, this is a lose/lose for everybody except bankruptcy attorneys. By comparison, the short time horizon the poor tend to prefer to take risks within (Portfolios of the Poor finds two years to be a general rule of thumb) seem like a great way to accomplish a house over a number of years with a combination of steps involving savings and microcredit.

    So, can we reach the poor with mortgages? I think eventually; and in some countries soon. But, I think market dynamics will naturally extend to middle class households first. With so much of the world’s middle classes still without formal mortgage finance, that may take a while.

    Posted by kelleypatrick | November 1, 2011, 16:34
    • Thanks Patrick – lots of meaty issues here, but I almost hear you saying either you offer unsecured loans, or you offer micro-mortgages. I am sure you will agree we need both!

      I couldn’t agree more that micro-mortgages are a solution for working poor in most markets, not the $1/day folks that “Portfolios of the Poor” focused on (although interestingly if you look at the household demographic, some households are made of 5-6 $1/day earners and perhaps a salaried earner, which may push the household into the ‘working poor’ category rather than the ‘very poor’). That’s OK by me – different strokes for different folks!

      Great example of a hurdle with the transaction cost issue. Who is working on that?

      Regarding risk transfer, that is a very important factor for micro-mortgage lenders and regulators to consider as part of their consumer protection framework. But if we think about transactions where risk would be increased, it would be a scenario where a family is giving up an asset with high value (such as a paid in full house or piece of property), for an asset with low value (another property with a big mortgage obligation). But what happened to the asset? Normally it would be preserved as equity in the new property (down payment), or another investment. So there is no downside loss of the asset, even in the case of liquidation of security (unless the loan value is more than the value of the property, which is why savings is vitally important – to prevent people from getting upside down on their obligations). But perhaps more common will be those trading rental accommodation for a home with a mortgage. In this case, the savings would be the initial asset that becomes equity in the home, and that would grow over time as the mortgage is repaid. Again, risk would only increase due to exogenous factors.

      Posted by housetheplanet | November 2, 2011, 10:53
  2. It’s very good to be talking about this because I completely agree: home ownership is one of the things that separates the rich from the poor, the haves from the have nots. My life changed when my wife and I bought a home 25 years ago. We got more security, along with more stress.

    The phrase “micro-mortgage” suggests that housing finance for the very poor is like finance for the better off, differing primarily in scale. I’m not sure that’s true, any more than a mosquito is “just like a bird, only smaller”. A couple of things differentiate micro-mortgages from mortgages besides size (just like the absence of feathers goes beyond size in differentiating mosquitos from birds). My mortgage in the US gives me the hope of value appreciating, justifying the risk and expense. I have clear and insured tenure, and there is an active re-sale market for houses. Those conditions just don’t apply in much of the world.

    When I worked in microcredit, many clients borrowed for housing. They sometimes had a strange quasi-ownership of their property: they owned it enough that they couldn’t be evicted, but not enough to be able to sell it. (My neighbor in Morocco enjoyed showing me an ancient document signed by a long-dead prince that gave his family the right to live in the house – you could not pry him out, but he couldn’t sell it). And improvements in housing were often a business: people would fix up a room in order to be able to rent it out, often while cramming their children into much smaller spaces. As with other micro-credit loans, both the loan and the repayment came out of a swirl of different revenue streams; there was often a disconnect between what the loan was used for, and the source of its repayment.

    The motivations around housing and the cultural conception of housing are quite different in much of the world from what I have grown up with. People want housing finance everywhere I assume, but in some places, it might look a lot more like traditional micro-loans, than like micro-mortgages. That doesn’t have to be a problem.

    I love the low-cost houses you link to. Smaller homes are getting some traction even in the US, home of the McMansion. For instance, see this: http://tinyhouseblog.com/

    Posted by Paul Rippey | November 1, 2011, 17:30
  3. So the question is: what market characteristics make micro-mortgages feasible? You name a few (active property market, good title). I suspect all these factors come together more in urban and sub-urban areas. In India I see a lot of emphasis on micro-mortgage in housing estates (although these are probably larger than what you are talking about, but still making a decent, safe and affordable house possible for low income salaried workers).

    I too see lots of improved homes being used to generate revenue (e.g. using a new room to rent out and generate income, leaving the family crammed into a small space). I don’t know if that is a good thing or a bad thing – I know there are standards for the amount of space each person should have, but my free market tendencies say let the people decide!

    Posted by housetheplanet | November 2, 2011, 11:13

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