This article has been condensed from one that originally appeared in Secondary Mortgage Markets, published by Freddie Mac.

Community lending moved to the forefront of industry issues in 1993 for primary market lenders as well as for Freddie Mac [Federal Home Loan Mortgage Corp.] and Fannie Mac [Federal National Mortgage Association], the two housing government-sponsored enterprises (GSEs). For lenders, proposed modifications to the Community Reinvestment Act regulations became a focal point in the community lending debate. The modifications were spurred by a desire to shift the regulatory emphasis from the process lenders go through to promote community lending to actual lending performance.

For Freddie Mac and Fannie Mac, meeting the interim housing goals was the corresponding regulatory focus. By law, the Department of Housing and Urban Development is required to set two annual mortgage purchase goals that address the needs of very-low-, low- and moderate-income families. In addition, the GSEs must meet a geographic purchase goal designed to boost mortgage purchases from areas that are currently underserved by mortgage markets.

For 1993 and 1994, HUD defined the "underserved" goal in terms of the percentage of GSE mortgage purchases financing housing units located in central cities. For 1995 and beyond, Congress envisions that the central-city goal should be "redefined and expanded to include rural areas and other areas with relatively poor access to mortgage credit."

Many in the mortgage.industry have questioned whether the central-city designation is an appropriate proxy for segments of the mortgage market that may be underserved. The central city, or cities, of a metropolitan statistical area receive that designation by the Office of Management and Budget based on population and economic considerations; mortgage credit availability and housing stock quality are not factors. As a result, OMB-designated central cities have widely varying housing and mortgage credit needs.

Contrast Scottsdale, Ariz., with East Orange, NJ. According to the 1990 census, Scottsdale, which is designated as a central city, is 96% white, with 3% unemployment, low poverty (4% of families below the poverty level) and a homeownership rate equal to the national average of 64%. East Orange, on the other hand, is located just outside Newark and is not designated as a central city. It is 90% African-American, with relatively low homeownership (28%) and relatively high unemployment (7%). And 18% of families live in poverty.

East Orange undoubtedly has more unmet mortgage needs, yet the central-city purchase goal focuses more attention on Scottsdale.

Defining underserved areas in terms of rural neighborhoods may prove to be similarly problematic.

Economists characterize underserved areas as having an unmet demand for mortgage credit or credit that costs more than it would in a competitive market. To make this definition practical to the mortgage industry, Freddie Mac used the two-year transition period to examine the characteristics of underserved areas. Using 1990 census data and 1992 HMDA data, Freddie Mac has found that mortgage credit flows have more to do with a neighborhood's average income and minority concentration than purely geographic distinctions.

Although central-city and rural census tracts have lower applications and originations per unit than suburban tracts, low- and moderate-income and high-minority-share census tracts show larger shortfalls. Neighborhoods that are greater than 50% minority have five originations per 100 units compared to 11 in neighborhoods that are less than 20% minority. Similarly mortgage originations in low- and moderate4ncome neighborhoods (at or below the MSA median) are significantly lower than those in upper-income neighborhoods.

While the HMDA data cover both applications and originations, as much as a third of all lending was excluded in 1992. Many loans originated outside MSAs, as well as originations made by very small lenders, were not reported. Residential Finance Survey data, which capture total lending volumes, also show originations per property to be lower in central cities than elsewhere in an MSA.

Like other analyses of aggregate mortgage originations, Freddie Mac's study indicates that lending disparities exist in minority and lower-income neighborhoods. Income and minority concentration appear to be better indicators of areas with mortgage credit needs than central-city or rural location, housing age, or structure type. These findings suggest that to be effective in boosting mortgage flows, the definition of underserved areas underlying permanent GSE purchase goals should focus on the race and income characteristics of census tracts, wherever they are located.

A low- and moderate-income neighborhood goal would complement the existing low- and moderate-income borrower goal, which allows for borrower mobility, while a goal based on the minority concentration of neighborhoods combined with efforts to reduce mortgage discrimination could help boost minority originations. Defining central cities, rural areas, and other underserved areas as low- and moderate-income neighborhoods (up to 100% of the MSA median income) and those with higher minority concentrations than the nation as a whole (greater than 20%) targets areas that are most likely to be underserved. This definition would cover 39% of 1992 conventional origination reported under HMDA.

This definition applies to between 95% and 100% of households in selected large central cities with high concentrations of underserved neighborhoods.

Less than a quarter of house, holds in small, affluent central cities such as Scottsdale would he covered; however. In contrast, the definition would cover nearly 100% of households in East Orange and other underserved areas that are outside OMB-designated central cities.

By including neighborhoods with 20% to 50% minority concentrations, this definition could promote mobility and integration. It also recognizes the need to focus attention on transitional neighborhoods. Finally, since 25% of African-Americans live in neighborhoods that are between 20% and 50% minority, including these neighborhoods in the definition of underserved areas could help boost African-American origination rates.

In focusing the goal on, areas with greatest needs, this definition captures the spirit of the 1992 legislation. It challenges both GSEs to create better mortgage delivery systems, not just establish special programs to meet narrowly focused goals. Adapting mainstream programs to meet the needs of underserved neighborhoods ensures these neighborhoods a long-term, low-cost, sustainable source of mortgage credit.

By SUSAN WHARTON GATES Senior policy specialist, housing economics Freddie Mac

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