Community Reinvestment Act Rule Revision Can Boost Small Mortgage Loans

Congress passed the Community Reinvestment Act (CRA) in 1977 to encourage local financial institutions to help meet their communities’ credit needs, particularly in low- and moderate-income neighborhoods. Now, the Federal Reserve Board is considering ways to modernize CRA regulations to reflect how the sector works in the 21st century creating an opportunity to reverse the years-long decline in the availability of mortgage loans under $150,000.

Under the CRA, regulators evaluate specific bank services and lending, such as mortgages in certain underserved areas where the banks have branches; the financial institutions receive CRA credit, or points, for those activities and products. Most banks pass these tests, however, making it difficult to assess the CRA’s overall effectiveness.

Perhaps more importantly, the industry today bears little resemblance to what it was nearly 45 years ago when the CRA was enacted: Banks increasingly do business online and offer a wider range of products and services. In September, the Federal Reserve issued its proposal for modernizing CRA to reflect these changes and to reconsider the ways in which banks can earn credit for lending to people in low- and moderate-income neighborhoods and underserved communities. On Feb. 16, Pew sent a letter supporting the board’s goal of updating the act but noted opportunities for improvement.

CRA encourages access to mortgage credit

Single-family mortgages account for most of the CRA credit earned by banks. This positive contribution to overall mortgage origination, however, has not countered the dearth of small mortgages, even in areas of the country where many low-priced properties are available.

This lack of small mortgage financing makes it tougher for some creditworthy households to purchase affordable housing and start the climb up the homeownership ladder. It also can have important implications for borrowers’ ability to achieve economic stability and build generational wealth. Although there are alternatives to conventional mortgages, these have fewer consumer protections and often carry higher costs. The proposed CRA reforms could help improve access to small-dollar mortgages for families looking to purchase low-cost homes.

Expanding assessment areas could encourage lending in areas with low-cost housing

Low- and moderate-income families are more likely to live in low-cost homes. Lending to these borrowers is typically higher in what are known as CRA assessment areas, the geographic locations that a bank can reasonably serve and for which it will receive credit. The current evaluation system, however, limits assessments to those areas where banks have offices, branches, or ATMs. That means banks then have little incentive to lend beyond these places, which can lead to concentrations of lending activities. 

Although geographically bound assessment areas continue to be a key driver of CRA lending, many critical banking functions are moving or have moved to the internet. Therefore, it would make sense to reevaluate the assessment areas and include substantial activity beyond the areas around branches as well as lending by online banks that do not have physical locations.

Any decision on whether the new assessment areas should be based on levels of deposit-taking and lending, or should simply be nationwide, will require more research. Regardless of the final decision,  the approach should not encourage credit hot spots or deserts.

The CRA proposal helps to incentivize small mortgages

For decades, CRA credit from mortgage lending has been based on total dollars lent, which tends to motivate banks to focus on larger loans at the expense of smaller ones that could serve many low- to moderate-income households. Thus, the board’s proposal to count mortgage lending based on the number of loans—rather than the total value—should incentivize banks to issue more small mortgage loans.

This can help to discourage banks from offering only those products that generate the most dollar volume and encourage them to serve more people. Further, regulators could take this approach when determining what to include in a CRA evaluation in the first place by considering only those bank products that produce a high number of loans.

Home mortgage loans that banks purchase from other lenders also should be evaluated for CRA credit. Such purchases on the “secondary market” promote liquidity by freeing up funds so that banks and other lenders can make new loans to low- and moderate-income borrowers. However, purchased loans should not be eligible for CRA credit more than once so that banks receive a reward for facilitating new loans to less affluent families and underserved communities but not for multiple resales of existing loans. 

CRA credit can be expanded to include areas with low mortgage lending

Banks also receive CRA credit for lending to community development projects. But these projects sometimes take place outside banks’ assessment areas, though still in areas of need, such as communities with low levels of mortgages. By giving CRA credit for lending to areas of need, regulators could improve the volume of small-mortgage origination to better meet demand. 

Regulators will need to maintain a focus on the dearth of small mortgages as the CRA continues to be used as a tool for encouraging lending to low- and moderate-income and underserved communities. They can update the CRA regulatory and supervisory framework to foster a more robust small-mortgage market and provide a path to homeownership for many creditworthy families wishing to purchase low-cost homes.

Nick Bourke is a director and Tracy Maguze is an officer with The Pew Charitable Trusts’ home financing project.