Flawed US Home-Loan System Neglects the Buyers Who Need It Most

The tiny town of Drew, Miss., has been left behind by the modern economy. Most businesses along its lone main street are shuttered, so it’s hard to buy a cup of coffee or groceries. Stray dogs zigzag through ragged yards, surrounding dilapidated homes that sit abandoned or in barely livable condition.

Money comes easy in some neighborhoods, dotted by plantation homes that have been passed down for generations. But it’s difficult to find banks willing to give home loans to the low-income, Black residents who make up the majority of the population — a flaw in a US government-backed lending system meant to help aspiring buyers in communities like these.

James Green, a heavy-machine operator for Sunflower County, tried for more than a decade to get a mortgage in Drew. Regions Bank, one of the biggest lenders in the South and where he kept his money, denied his loan application three times, he said, telling him his credit scored too low. Two other banks said the same. It wasn’t until Hope Credit Union, a Black-owned, community-focused lender, came to town that Green could finally buy a house at the age of 48.

“I just made my first mortgage payment on Aug. 1,” Green said. “My wife broke down crying on the phone when we paid that $601.25 — tears of joy after all the hurdles and hoops I had to jump.”

There’s a key difference between Hope and giants such as Regions: their access to Federal Home Loan Banks. These 11 institutions sit atop a $1.4 trillion system with a stated mission of supporting affordable housing and community development. But this system is tilted more toward big US banks and insurers that borrow billions of dollars — for uses that often have nothing to do with mortgage lending — than smaller, community-focused lenders that help support homebuying for low-income Americans.

Across the country, large banks are creating fewer homeownership opportunities per dollar that they borrow from the FHLBs than small banks and mission-driven lenders known as Community Development Financial Institutions, according to a Bloomberg News analysis of more than 5,700 bank and credit-union members. Community banks and CDFIs devoted more of their home lending to low- and moderate-income census tracts than larger institutions in every year from 2018 to 2022.

At the same time, these smaller lenders can face constraints in how much they can tap from the home-loan banks. And they often pay more for the help they do get, because they’re viewed as riskier borrowers.

The divergence is more pressing now than ever as the US struggles with an affordable housing crisis and the FHLBs themselves come under increased scrutiny. The institutions, created to shore up the mortgage market during the Great Depression, have strayed from those roots to become a go-to for big firms in need of quick cash at cheap rates. That includes billions of dollars in financial support to now-failed companies such as Silicon Valley Bank, known for catering to tech entrepreneurs and venture capitalists, and Signature Bank, which had clients including crypto platforms.

“In so many ways, it’s the small institutions that really are the critical resources in the lives of their communities,” said Michael Stegman, a non-resident fellow at the Urban Institute and housing policy adviser to the Obama administration, who has advocated for reforming the FHLB system. They “are closer to the historical mission of the home-loan banks.”

The FHLBs take many factors into consideration when making lending decisions, including credit ratings and collateral, so they can run safe institutions, said Ryan Donovan, chief executive officer of the Council of Federal Home Loan Banks. He said they depend on policies set by the Federal Housing Finance Agency, which oversees the institutions.

“CDFIs present a unique risk profile and are rated differently from a credit perspective based on FHFA guidance,” Donovan said in an interview.

This month, the FHFA is expected to release a report detailing regulatory and legislative proposals that could better align the home-loan banks’ activities with their congressional mandate to “promote economical housing finance.” In a statement, the agency said it’s finalizing recommendations including ways to improve support for lenders doing the most for community development and housing.

Changes under consideration include a cap on loans that the FHLBs make to large financial institutions, Bloomberg News reported in June. Officials also are looking at ways to give more financial firms, including nonbank mortgage lenders, the ability to borrow from FHLBs to strengthen the system’s connection to home loans, people familiar with the matter said last month.

“There’s a lot of focus in our discussions with them on affordable housing and community investment,” Winthrop Watson, CEO of the Pittsburgh FHLB, said of the talks with regulators during an interview with Bloomberg last month. “We can do more on that front that could really add significantly to our franchise.”

Differing Terms

FHLBs use special tax breaks and government support to raise funds cheaply in bond markets. They then pass along low rates to the banks, credit unions and insurance companies that make up the bulk of their membership.

Larger banks are given more leeway by the FHLBs for borrowing money since they are seen as more financially sound. Instead of strict collateral requirements, they can often get a broader lien on their books. CDFIs typically face higher borrowing costs and often make other types of loans to help their communities that can’t be pledged to borrow from the FHLBs, according to interviews with more than a dozen such lenders, current and former government officials and employees of the system. The difference in treatment is so stark that in some cases large private banks offer community lenders better access to capital than the FHLBs themselves.

Regulators require banks to invest and provide services for low- and moderate-income Americans, and one of the ways they can meet these conditions is by giving credit to CDFIs. But unlike the government-subsidized FHLBs, the big banks often aren’t able to offer the lowest rates and options for long-term funds, which are needed for mortgage lending.

Community lenders are often the only path to homeownership for people like Tara Carmichael, an ultrasound tech in Newark, Ohio, who said she was for years unable to get a loan with traditional banks in her area. The mother of four went to TrueCore Federal Credit Union, which advised her how to bring up a 580 credit score. A year later, Carmichael’s score was 685 and she got a mortgage with TrueCore to buy her first home.

“They told me which credit cards to pay down, which ones to cut up,” said Carmichael, 43. “They seem more willing to give people with lower credit a chance.”

TrueCore gives around 70% of its mortgages to lower-income borrowers. Many investors aren’t willing to buy these loans, deeming them too risky, so the company must keep the debt on its books. With that money tied up, it’s harder to issue new loans.

The lender has a $43 million line of credit from the Federal Home Loan Bank of Cincinnati but can only pledge single-family mortgages as collateral. Auto loans, business loans and other assets aren’t accepted. As a result, TrueCore mostly relies on the FHLB money to subsidize the home loans it has to hold on to, rather than for new mortgages, said CEO Jason Hall.

“I like the safety net that they provide,” Hall said of FHLBs. “But I always look to get funds from our members first.”

As a credit union, TrueCore is regulated. Other CDFIs don’t take deposits and have less oversight. But even as these lenders have become a bigger force in financing housing for low-income and low-wealth communities, most have done so without taking excessive risk, according to Fitch Ratings. They generally have low loan delinquencies and strong financial profiles, the credit agency said in a May report.

Pledging Assets

In Mississippi, which has the highest poverty rate in the nation, CDFIs such as Hope are filling the gaps where even basic banking services are difficult to come by. But Hope is hamstrung by a relatively small line of credit — currently around $46 million —  from the Dallas FHLB, according to a federal filing.

To draw from that, Hope typically has to pledge loans worth 25% more than what it borrows from the home-loan bank. That gap is what’s known as a “haircut,” and the FHLBs impose it to make sure that they’ll be made whole if a member defaults on an advance. These discounts can vary widely, but the haircut Hope faces is higher than the 19.8% discount the FHLBs applied to first-lien, single-family mortgages, on average, according to data FHFA compiled for Congress. That’s despite the fact that Hope’s mortgages have performed well, with a loss rate of 0.19% in 2022, according to the CDFI.

Regions, a unit of Birmingham, Ala.-based Regions Financial Corp., which has about $155 billion in assets, operates in many of the same counties. It had a $5 billion balance outstanding from the FHLB system at the end of June, and at other points in recent years had more than $8 billion in borrowing from the home-loan banks. It can support these debt levels because its balance sheet is stuffed with the kinds of assets the FHLBs accept, including Treasuries and mortgage-backed securities.

But home-lending patterns for Regions and Hope couldn’t be more different.

In parts of the Mississippi Delta where both banks have made mortgages, such as Leflore and Bolivar counties, immaculately maintained estates sit just a few miles from run-down “Katrina cottages,” occupied almost entirely by Black residents renting homes in need of major repairs.

Unlike some of the heaviest borrowers from the home-loan banks, Regions is active in the mortgage business and makes substantially more in loans than it takes from the system. But federal disclosures show that the bank focuses on more affluent areas and lends predominantly in Mississippi to White homebuyers. Regions made just a 10th of its home-purchase loans in low- and moderate-income census tracts during the past five years — a rate comparable to the broader industry. It directed 21% of loans to borrowers who identify as Black in a state with a Black population of nearly 40%.

Regions donated some Mississippi branches to Hope starting in 2015. Before that, the bank offered minimal financial services in Drew and the surrounding areas, locals say. Customers said they would often have to drive a half an hour or more to open a bank account or to find a location with a working ATM. “They started doing less and less,” George Holland, the mayor of Moorhead, Miss., said of Regions. “Maybe once a week there’d be somebody here if you wanted to open a new account.”

A lack of banking options in underserved areas can have a ripple effect: It’s hard for people with little access to financial services to build credit history — thus making it even more difficult to get a mortgage. Mississippi has the highest percentage of people in the US without bank accounts, according to the Consumer Financial Protection Bureau.

Jennifer Ardis Elmore, a Regions spokesperson, said the company is actively serving the Mississippi Delta, including providing credit to people in low- and moderate-income areas. The bank chose to donate four properties to Hope because “a community partner was in a better position to maintain services in specific communities,” and it made a $500,000 cash contribution to help with the lender’s expansion, she said.

“When banks like Regions support CDFIs like Hope, we collectively create tremendous results for individuals and communities,” she said, adding that it’s misleading to directly compare the two different types of lenders.

Regions takes access to credit “very seriously” and wherever possible works with consumers who may not qualify for loans to help improve their financial strength, Ardis Elmore said. It also is involved in community engagement and philanthropic work to support organizations that serve people across the region, she said.

Part of what community lenders do is work with Americans who can’t qualify for a home loan to improve their finances. They also keep loans affordable by eliminating mortgage insurance or other expenses. Since 2018, Hope has made more than 80% of its home loans in Mississippi to Black borrowers and lent in poorer areas at two-and-half times the rate of Regions, according to federal mortgage disclosures.

“We get people into homes so they can start building wealth,” said Bill Bynum, Hope’s CEO. “If the mission of home-loan banks is to promote affordable homeownership, they should be taking steps to make sure CDFIs are adequately capitalized and that there’s flexibility. But we’re perceived as higher risk.”

Some smaller lenders and CDFIs opt out of joining the FHLB system altogether, because the terms are prohibitive.

Homewise, a New Mexico-based CDFI, decided not to be a member of the Dallas FHLB after a meeting that determined the bank would lend Homewise 60 cents on the dollar, said CEO Mike Loftin. His CDFI issues up to $60 million in mortgages annually, mostly for first-time buyers.

“We’d be an obvious partner,” Loftin said. “And we’d love to be able to reach people that we’re not, but we can’t afford that.”

Instead, the CDFI borrows from big lenders including Bank of America Corp., which offers a more reasonable collateral requirement — Homewise gets $1 for every $1 it pledges. But it pays a higher interest on the debt.

“We’re strong as an institution and our lending record is good,” Loftin said. “Just because we’re focused on first-time homebuyers and people who have been left behind historically, doesn’t mean these aren’t good borrowers.”

More credit could go to small banks, said Dayin Zhang, an assistant professor of real estate and urban land economics at the University of Wisconsin–Madison School of Business. His research has shown that FHLB advances can dramatically help these small players in home lending and lower the interest rates consumers pay, without making riskier mortgages.

“We need small banks to be in the market,” he said. “They’re more responsive to local economic conditions.”

Many residents in the Delta would agree. In an area where cash advances and predatory loans are advertised on big signs along rural highways and in the windows of gas stations, community lenders offer an opportunity for people to build financial profiles, and eventually wealth.

Green, who bought the house in Drew, took out a $50,000 mortgage from Hope. His three-bedroom rancher is one he’d rented many years earlier and is rich with memories, like his wife going into labor with their second daughter. Since becoming a homeowner, he has become something of an advocate, meeting with locals who want to learn more about the process of getting a mortgage.

“Now I can help others who want to own a home,” said Green. “I want people to live they way I live.”

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