Five years after the mortgage industry revved up special programs to finance homes for Americans with low and moderate incomes, soaring late payments have raised questions about the future of the initiatives.

The nation's largest independent mortgage banker, Countrywide Home Loans Inc., reports that the 41,000 borrowers in its $3.5 billion affordable- housing program are delinquent at about three times the average rate of just under 3% for conventional loans.

NationsBank Corp., which has made about $1 billion of similar loans, reports comparable lateness. Catherine P. Bessant, senior vice president, said NationsBank's program has delinquencies two to three times as high as on standard mortgages.

Though some lenders have reported less severe delinquency rates on affordable-housing loans, industry analysts said they attached more importance to the broader-based national figures from lenders like Countrywide.

The lower-income borrowers at both Countrywide and NationsBank have made only small down payments, have little money set aside for emergencies, and are often inexperienced at managing debt.

Ms. Bessant said that "layered risk" borrowers show the poorest performance. "When we do loans that have a high loan-to-value ratio, and minimal cash down, and flexible debt ratios, for example, then we have a strong differential" between the affordable and standard books of business, she said. "When we limit our risk layering to one or two special factors, we have much better performance."

It's no surprise that more of the new borrowers are tardy than traditional borrowers, executives point out. The new borrowers, in lower- level jobs, often aren't protected by the severance agreements, health insurance, or savings accounts that help middle-class homeowners to ride out tough times.

What has made industry executives sit up is how much worse the new programs are doing relative to the standard book of business, and even to their own expectations. And the situation is expected to worsen in the event of an economic downturn.

Some worry that affordable-housing programs may ultimately languish because they just don't make enough money.

"Unless you can demonstrate to lenders and investors that this business can perform comparably to other business, it will suffer," said Gordon H. Steinbach, executive vice president of affordable housing at Mortgage Guaranty Insurance Corp. "We will not be able to do what we all hoped to do in the affordable-housing area."

At MGIC, a leading provider of default insurance, delinquencies on affordable loans insured in 1994 and 1995 are 2.3 times higher than on traditionally underwritten loans with a 5% down payment - and profits on the new business are "well below our target return," Mr. Steinbach said. Some segments of the affordable-housing business have five to six times higher delinquencies, and there the insurer is "likely to lose money or at best break even," he said.

The nation's two largest mortgage investors, Fannie Mae and Freddie Mac, have taken steps to protect themselves from high risks posed by targeted borrowers with especially weak credit scores.

Borrowers with standardized scores below 620 are seen as poor credit risks, and the agencies have asked lenders to scrutinize them closely. Their research has found that losses are concentrated among these borrowers.

Though the agencies dispute it, some lenders say that credit scores are being used to restrict credit unfairly to many low- and moderate-income borrowers.

Angelo Mozilo, chief executive of Pasadena, Calif.-based Countrywide, said the lender sends most of its low-credit-scoring borrowers to the FHA program because Fannie and Freddie have branded low-scoring loans undesirable.

Low-scoring loans are intensively audited by the secondary-market agencies, lenders say, and the agencies are more likely to ask lenders to buy back the loans.

Freddie Mac also discourages this business by charging higher guarantee fees if risky loans make up more than a set percentage of overall sales to the agency, Mr. Mozilo said.

The nub of the matter, he concluded, is whether the secondary market agencies and private insurers, who "have had an enormous return on equity," can "tolerate a higher delinquency ratio and possibly a smaller profit margin" as they pursue this business.

Along with mortgage insurers, Fannie Mae and Freddie Mac also are trying to steer clear of risk layering, the practice of bending several underwriting standards to accommodate targeted borrowers. The practice evolved as the guidelines were relaxed.

Still, Fannie Mae, formally the Federal National Mortgage Association, says it has not backed down at all on its much-publicized and politically sensitive commitment to help low-income homebuyers.

"We started out with an expectation that the performance (of these loans) would look different, and it has," said Barry Zigas, senior vice president of Fannie Mae's National Housing Impact Division. "But it's a business we have been and remain very committed to," Mr. Zigas said.

Freddie Mac, formally the Federal Home Loan Mortgage Corp., declined to comment for this article.

The new credit scoring represents not so much a tightening of credit standards as an enforcement of existing ones, said Robert J. Engelstad, senior vice president of mortgage and lender standards at Fannie Mae. But, Mr. Zigas added, Fannie Mae wouldn't hesitate to act "if we encounter situations where we find people being put in unjustified jeopardy (and) performance that is way outside our expectations."

To be sure, not all lenders report such a big gap in the performance of their affordable-housing and standard portfolios.

For example, at American Savings Bank in Irvine, Calif., 1.95% of the thrift's $2 billion targeted loan portfolio was 30 days behind on monthly payments. That was 56% higher than delinquencies on the thrift's standard loans, said John R. Donohue, executive vice president for lending. But more of these loans "cure" before defaulting, he said.

Of the affordable housing loans, 1.3% were 90 days or more overdue, compared with 0.8% of standard loans.

In setting interest rates on these mostly low down payment loans, American factors in higher credit losses and the cost of salespeople and appraisers who know their local markets intimately, Mr. Donohue said. Most years, the targeted loans account for one-fifth of all home loans American makes, and the thrift finds the business profitable, he said.

Another large California-based lender, Bank of America, has seen its targeted loans perform at the same level as the standard book of business, said spokesman Russ Yarrow.

Most observers agree that the mortgage business is still working out how much risk it will take on, as it tries to meet political and business pressures to serve nontraditional borrowers.

It is generally argued that lower delinquencies at depository institutions reflect their intimate knowledge of local markets as well as intensive pre-screening. Mortgage bankers, who buy their loans wholesale from brokers, don't have the same advantage.

But experts add that it's unclear which of the two approaches better serve the public policy goal of putting more low-income Americans into their own homes. With intensive pre-screening, fewer applicants get home loans, but more of them probably can hang onto them.

Under the wholesale approach, more loans are made, more go bad, but the programs may still turn a profit by charging high enough rates.

Many, such as Mr. Steinbach of MGIC, are hoping that the wholesale approach will be modified, as borrowers go through intensive homebuyer education - before, during, and after they purchase the home. Mr. Steinbach said he thinks such programs would go a long way in improving loan performance, and could make low-income lending efforts quite viable over the long haul.

By contrast, lenders such as Mr. Mozilo appear to be arguing for the other approach. Though Mr. Mozilo acknowledged that some targeted lending may have been too aggressive, he said he believes that it would be preferable to require more insurance on these loans than tighten credit. But he, too, believes homebuyer education should help cut delinquencies.

But if delinquencies don't drop, he and others warn that the mortgage industry's new efforts could founder, and low-income would continue to be served mostly by government programs.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.