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September 26, 2008

CDFIs Offer Responsible Alternative to Predatory Lenders
    by Robert Kropp

Community development financial institutions provide housing loans to underserved markets, yet maintain profitability and low net charge-offs. Part II of a three-part series on the credit crisis.

SocialFunds.com -- As Congress and the Bush Administration wrangle over the particulars of the proposed $700 billion bailout of tottering mortgage giants and Wall Street investment firms, taxpayers and homeowners look on and wonder—what happened? Who is to blame for a crisis that leaves us in such precarious straits, and has forced so many people from their homes?

Please support
our sponsors"The situation reminds me of Murder on the Orient Express," said Mark Pinsky, President and CEO of Opportunity Finance Network, regarding the collapse of the subprime lending market and the subsequent financial crisis. "After his investigation, Poirot concluded that everyone on the train was responsible for the murder. Everyone from lenders to government regulators played their part in this crisis."

Predatory lenders devised loans that in the short term were affordable to low-income borrowers and those with questionable credit. But devices such as "exploding ARMs" (in which a fixed loan rate is replaced by a much higher adjustable rate after a period of time, usually two or three years), when combined with the decline in housing values, made
mortgages unaffordable and refinancing impossible.

But Pinsky was quick to add, "The system-wide failure was brought about by bad lending, not bad borrowing." He contrasted the high rates of delinquency and default on loans originated by predatory lenders with the success of the lending practices of community development financial institutions, which provide credit to underserved, low-income markets.

CDFIs succeed by developing knowledge of the communities in which they do business and by developing relationships with their customers. CDFIs display a commitment to spending time on individualized service and programs tailored to the needs of underserved markets.

Many customers of CDFIs are first-time homebuyers who need help with the process of buying a home. CDFIs often offer nonfinancial services such as homebuyer education courses and counseling on how to avoid predatory lending.

The successes enjoyed by CDFIs encourage conventional lenders to become involved, thereby increasing the amount of available credit in underserved areas.

The collective experience of CDFIs is at the heart of Opportunity Finance Network's recent publication The NEXT American Opportunity: Good Policies for a Great America. The book chronicles the years of success that CDFIs have had in serving the same socioeconomic groups—low income, minorities, households run by single women—that the conventional subprime lenders have sought and failed to serve in a prudent manner. The NEXT American Opportunity "offers more than 200 concrete, specific recommendations for federal policy."

In the book, Martin Eakes, CEO of Self-Help Federal Credit Union, a CDFI based in Durham, North Carolina, uses a literary reference to get his point across. However, his reference is much more elementary. In his contribution to The NEXT American Opportunity, Eakes writes:

"Like most CDFIs, Self-Help takes what might be called a 'Three Bears' approach to lending: potential borrowers can be too hot, too cold, or just right."

Borrowers with adequate incomes and good credit are usually referred to conventional lenders, where they may be able to attain a better interest rate. In the cases of borrowers with bad credit, Self-Help and other CDFIs work with them to clean up their credit rating, so that they may qualify for a loan in the future. If the CDFI's loan officer determines that the borrower is a reasonable risk, then the loan is made.

Pinsky of Opportunity Finance told SocialFunds.com, "The perceived risk that drives conventional lenders away from the nonconforming borrower is often far more pronounced than any real risk." In fact, in 2006, CDFIs wrote off .45% of their mortgage loans, comparable to the .39% of conventional lenders. Although these numbers are comparable, it is important to note that CDFIs lend exclusively to lower income borrowers.

In comparison to the low net charge-off rate on CDFI loans, one in five families that received a subprime loan have lost or will have lost their homes to foreclosure, resulting in a loss of equity of $164 billion. The effect of widespread foreclosure on neighborhoods cannot be discounted. It is estimated that for every foreclosure, neighboring houses lose $5,000 in value.

In the case of multiple foreclosures—not at all uncommon in already distressed minority neighborhoods, whose residents have been victimized by predatory lending to a disproportionate degree—the home values in the surrounding neighborhood decrease even more dramatically.

The CDFI Coalition reports that since the 1994 creation of the CDFI Fund, a government agency that provides funding to individual CDFIs, 800 CDFIs have been certified. There are an estimated 1200 CDFIs operating in the US, lending in communities in all fifty states and the District of Columbia.

According to the CDFI Data Project, "505 CDFIs held $23.05 billion in assets and in 2005 invested $4.75 billion to create economic opportunity," including 69,893 affordable housing units.

The success of CDFIs can also be measured by their ability to attract private capital. According to Pinsky, "For each $1 the federal government has invested in CDFIs through the CDFI Fund, it has leveraged between $19 and $27 in new private sector investment."

The proposed federal bailout seems to present an opportunity to increase the visibility of CDFIs and offer them as lending and investment alternatives to the predatory lenders and the Wall Street investment firms whose activities precipitated the current crisis.

In a conversation with SocialFunds.com, Deborah Momsen-Hudson, Self-Help's Vice President for Secondary Markets, pointed out, "From our perspective, the crucial issue that needs to be included in any bailout proposal is granting bankruptcy judges the authority to modify loan terms in such a way as to allow people to keep their homes."

David Beck, Director of Self-Help Policy and Media, added, "Foreclosures currently in process far outnumber those that have been completed, so the possibility of many more people losing their homes remains a critical issue."

Eakes, who in addition to his position with Self-Help is a board member of the Center for Responsible Lending, said, "In North Carolina, Self-Help collaborated with a wide range of groups and advocated for the enactment of an anti-predatory-lending law. The law saved North Carolinians an estimated $100 million in its first year alone without drying up access to credit.

"Increased funding to the US Department of the Treasury's CDFI Fund and expanded Community Reinvestment Act regulations would generate additional private investment in housing, providing more affordable homes for both homebuyers and renters," said Eakes.

Eakes concludes, "It is essential for policymakers to ensure that an affordable and safe home is a reality for as many families as possible."

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