Two housing advocates who raised some of the earliest warnings in 2005 about the impending housing crisis are calling for a return to subprime mortgage lending.
Bob Gnaizda and John Hope Bryant realize it's a bit of a head-scratcher. Nevertheless, they are making the rounds in Washington and on Wall Street to promote their prototype for a responsible, alternative mortgage for less-than-prime borrowers.
"Talking about 'subprime' today is like talking about the devil," Bryant, the chief executive of Operation HOPE who serves on the president's advisory council on financial capability, said in an interview. "Nobody wants to use the word subprime, but frankly, we think that's the future."
Bryant and Gnaizda, the general counsel for the Black Economic Council, the Latino Business Chamber of Greater Los Angeles and the National Asian American Coalition, say the pendulum has swung too far in the other direction in the wake of the subprime crisis. Enhanced regulatory scrutiny has made lenders reluctant to offer loans to borrowers without pristine credit histories and hefty down-payments. That has had the unintended effect of redlining low- and moderate-income—and often black and Hispanic—borrowers.
Borrowers with lower incomes and those receiving smaller loans were more likely to receive higher-priced loans in 2011, according to a Federal Reserve analysis of Home Mortgage Disclosure Act data. Black and Hispanic borrowers also faced notably higher denial rates than Asian or white borrowers, the data showed.
Gnaizda and Bryant are proposing what they call the Dignity Mortgage, a loan that could be made to non-prime borrowers with built-in protections and incentives for both borrowers and lenders.
Under the proposal, Dignity Mortgages would only be available to people who complete certain financial literacy training, who have an income of 120% or less than the regional poverty level, and who are buying homes at 95% or less than the median price in the region.
In order to adjust for risks, lenders would be able to charge 1.25% above the lowest prime rate for a 30-year fixed-rate mortgage. If, however, the borrower makes timely payments for the next five years, the rate would be lowered to the lowest fixed-rate at the time, and the 1.25% premium would be applied to reduce the homeowner's principal.
In addition, a borrower could take advantage of a "reset clause" that would allow him to suspend payments temporarily during an emergency—such as job loss or the death of a spouse—provided he has made timely payments for a certain period of time.
And the kicker: if the loan met all of the above terms, Fannie Mae and Freddie Mac would be required to purchase the loan with limited or no recourse against the bank.
Bryant and Gnaizda suggest that the loans could represent only 20% of the market for the first three years, and should be treated as the equivalent of qualified mortgages for the purpose of calculating capital requirements.
Gnaizda, the former general counsel for the Greenlining Institute, said lenders should also be able to get credit for the loans under the Community Reinvestment Act, not only for lending but for service and investment.
Ultimately, the Dignity Mortgage could be a benefit to both borrowers and lenders, Bryant said.
"You get your dignity back," and "you get a chance in a capitalist society to reset your life without being called a bum or being pursued financially, or your credit ruined," Bryant said. "And the lender gets to not have Wall Street cite a bad credit and have the regulators call for more capital.”