Risky alternative financing is being used by millions: study

Approximately one in five borrowers nationwide, or about 36 million Americans, turned to a riskier, costlier and less regulated alternative to a mortgage at least once in their lifetime to finance a low-cost home, a new report reveals.

The Pew Charitable Trusts estimated around 7 million Americans, or one in every 15 current home borrowers, are still using alternative financing, according to research from a national survey published last week. Minority and low-income borrowers are more likely to use the alternate loans and be left out of consumer protections granted to federally-recognized mortgages.

“There's simply not enough small mortgages despite millions of low-cost site built and manufactured homes available and qualified buyers to purchase them because lenders have difficulty issuing small mortgages profitably,” said Tara Roche, a manager with Pew’s Consumer Finance Project.

The report defined small mortgages as those under $150,000, and said borrowers with household incomes below $50,000 were the most likely to use the mortgage alternatives. Alternative financing options include land contracts, seller-financed mortgages, lease-purchase agreements and personal property loans. The arrangements are associated with higher long-term costs, less favorable terms and an increased risk of losing home equity, Pew said.

No national data collection exists for alternative financing, according to the research, and almost no states require reporting for seller-financed mortgages or lease-purchase agreements. The lack of reporting can obscure ownership disputes, tax and upkeep responsibilities, natural disaster relief and insurance claim payouts, the study said.

Pew suggested insufficient evidence was available to explain why borrowers used alternative financing, although it indicated even financially capable borrowers face systemic barriers to accessing mortgages.

Hispanic and Black borrowers historically have historically had a more difficult path toward mortgage approval, the findings state. Low-income households have more volatile incomes and little-to-no credit history, impacting their ability to secure mortgages, according to Pew. The report also suggested underwriting hasn’t historically recognized borrowers’ rent payment history, although it noted Fannie Mae’s move to consider rent payments last year.

Manufactured homes have been cited by affordable housing advocates as a solution to the nation’s constrained housing supply, although prospective borrowers still face challenges in securing alternative financing.

The Federal Housing Finance Agency objected to plans filed by Fannie Mae and Freddie Mac on the Duty-to-Serve goals. Commenters had in particular noted the lack of a chattel manufactured housing goal.

Personal property loans are the most common form of alternative financing, as 11% of home borrowers have used them, Pew said. Meanwhile, more than half of applicants for personal property loans secured by manufactured housing are denied, according to a Consumer Financial Protection Bureau analysis.

Among other loan options, 6% of home borrowers have used lease-purchase agreements, 6% have used seller-financed mortgages, and 5% have used land contracts, according to Pew. The three options share risky features that can lead buyers to pay higher costs and can result in a default with potential loss of all funds paid.

“Because seller-financed mortgages and lease-purchase agreements are about as common as the better-studied land contracts and can lead to similarly harmful outcomes, they merit more research attention,” the report said.