Rethinking the 'Drive Till You Qualify' Life

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WE’RE HEARING the “new urbanism” may change the underwriting for home loans, especially if millennials maintain their preference for city living.

Leigh Gallagher, author of “The End of the Suburbs,” sees plenty of reason to believe that more and more people increasingly will favor city living over big houses in big yards far from city centers. Walkable streets, mixed-use and mixed-income development, and shorter commute times for residents are driving the appeal of the “new urbanism.”

And that trend could have huge consequences for the mortgage business. Already, there have been some experiments with “location efficient” mortgage loans. Like energy efficient home loans, the location efficient loans reward borrowers who live in areas close to job centers and shopping opportunities, presumably cutting down on the time people need to spend in cars and the money they spend on gas.

And one lesson coming out of the housing crisis is that the “drive till you qualify” lifestyle, which saw home buyers traveling to distant, sprawling exurbs in order to find dream homes at prices they could afford, may not have been such a good idea. Studies have found that default rates were higher in far flung suburbs than in most cities and closer in suburbs, and home values fell more in those far flung communities as a result.

“During almost every recession in our history, urban home prices have suffered the most. This time, the pain has been concentrated in the suburbs,” Gallagher wrote.

There are a variety of reasons that exurbs fared poorly in the housing bust, especially in large new developments. Too many people bought at the peak of the market in many new subdivisions, meaning virtually everyone found themselves underwater.

But Gallagher finds other reasons to believe that the big house with the long commute may not be a sustainable housing model. For one thing, most people don’t seem to like it.

“The housing crisis only concealed something deeper and more profound happening to what we have come to know as American suburbia. Simply speaking, more and more Americans don’t want to live there anymore,” Gallagher argues.

And that isn’t likely to change anytime soon if young people continue to express a preference for living in more vibrant communities with a less car-dependent lifestyle. Gallagher notes that 80 million millenials were born between 1977 and 1995, and a survey found that 77% of them prefer to live in an urban core.

Rising gas prices have proved particularly vexing for people living far from work, schools and shopping, making already “punishing commutes” unaffordable. In 2008, suburban households on average spent twice as much money on gas as they did in 2003, Gallagher found. (The average U.S. household spent nearly $3,000 on gas in 2008.)

“Economists say the cost of distance is starting to get baked into housing prices, sending valuations down in remote housing markets,” she wrote.

Another problem plaguing the development of low-density, sprawling communities is a kind of Ponzi scheme tax scenario. Often governments support the construction of infrastructure—roads, sewer and water systems, etc.—to lure development, but the property taxes from sprawling, low density communities are not sufficient to maintain those extra miles of road and pipes over time. As the need for repairs and maintenance adds up, as well as other civic services, sprawling, low density communities will find themselves facing steep tax increases or cutbacks in services, Gallagher argues.

Gallagher is sympathetic to the idea that commuting costs should be factored into mortgage underwriting. Research from the Center for Neighborhood Technology in Chicago, which focuses on neighborhood sustainability, has found that the average family spends 48% of its income on combined housing and transportation costs, including gas, the cost of cars, insurance, and maintenance. For working families with incomes between $20,000 and $60,000, that figure rises to 60%.

“Most people think about their housing costs without factoring in transportation, but the two are inextricably linked,” Gallagher said. “Plus, it’s the people who can least afford it who buy at the costliest distances.”

Gallagher recounts that Scott Bernstein, head of the CNT, helped create mortgages tailored to an “efficient location,” some 2,000 of which were purchased by Fannie Mae as part of a test program before the housing crisis, and Gallagher says the loans have outperformed other mortgage products. However, the idea languished in the wake of the housing bust as the industry struggled with trying to manage its way through the crisis. (HUD secretary Shaun Donovan is a fan, and Gallagher said the CNT and HUD are working on a proposal to create “energy star” type of rating systems for homes based on their likely transportation costs.)

One anecdote recalled in Gallagher’s book is that of a housing development on the outskirts of my hometown, the Minneapolis-St. Paul metropolitan area. “Drive 10 Miles and Save $10,000” was the developer’s billboard sales pitch.

The problem is, those 10 miles might cost well over $10,000 in commuting costs over time, according to a Twin Cities writer for the website mnstreets.com. Scott Shaffer argues that the failure to incorporate transportation costs into underwriting of home loans is a “glaring flaw” in quantifying a borrower’s ability to repay. (Citing AAA statistics on the cost of driving, Shaffer estimates those extra 10 miles would cost a typical homeowner $91,000 over the course of a 30-year home loan.)

Like Gallagher, I’m a native suburbanite who has chosen to live in urban areas most of my adult lifetime, sacrificing a certain amount of living space for the lifestyle appeal and convenience of city living, so I’m an easy sell on the new urbanism. And location efficient mortgages sound plausible to me, underwriting the collateral’s appeal because of its potential for lower transportation costs.

But actually incorporating an individual borrower’s transportation costs into mortgage underwriting might prove tricky. First of all, in a world in which most people change jobs more frequently than in the past, a borrower’s gas budget could change dramatically if they switch jobs. And trying to verify an individual’s transportation budget also could prove difficult, since it may be hard to verify what they self-report. (Not to sound cynical, but we all remember how no-income, no asset verification “liar loans” performed during the housing crisis.)

That said, the suburbs aren’t exactly likely to disappear anytime soon. In fact, 51% of Americans still lived in suburbs in the 2010 census. And many older suburbs and new developments are incorporating “new urbanism” into their planning and redevelopment processes.

I’d have to agree with Gallagher’s central premise—that the housing crisis has led people to rethink the appeal of big houses in low-density, exurban communities.

“Bigger is no longer better, credit is no longer limitless, and less is starting to become more,” is how Gallagher puts it.

Ted Cornwell has covered the mortgage markets since 1990. He is a former editor of both Mortgage Servicing News and Mortgage Technology.

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