NCPA - National Center for Policy Analysis

Location-Efficient Mortgages are Costly nd Risky

August 26, 2002

Polls indicate Americans are more concerned about urban sprawl than crime or unemployment. Among the many tools policymakers use to discourage sprawl, one of the most intriguing is the location-efficient mortgage (LEM). LEMs allow families who want to live in densely populated, transit-rich communities to obtain larger mortgages with smaller down payments than traditional underwriting guidelines allow. Advocates say LEMs curb sprawl by making homes in "location-efficient" communities more affordable to low- and middle-income borrowers who would ordinarily choose less expensive fringe areas.

However, some observers believe LEMs have more costs and risks than proponents claim. They find no demonstrable relationship between location efficiency and the probability of default. Therefore, making low down payment loans available to borrowers in location-efficient areas is tantamount to making such loans available to a random sample of borrowers. That, in turn, means the loans will exacerbate default risk.

  • While homeowners in location-efficient areas may actually enjoy transportation cost savings, those savings are simply not large enough to affect their propensities to default.
  • There are a number of reasons to believe that the estimates of transportation cost savings generated by the LEM computer model - often hundreds of dollars per month - are overstated.
  • The econometric model used to calculate transportation costs assumes vehicle miles traveled are particularly responsive to household density.

And in any event, real estate markets already efficiently capitalize any financial benefits from location efficiency into housing prices.

  • For example, it is well known that houses close to subway stops sell at a premium.
  • Thus, homeowners in location-efficient areas end up spending their transportation cost savings on higher mortgage payments, leaving their disposable income (and their ability to repay debt) unchanged.

Source: Allen Blackman, "Testing the Rhetoric," Regulation, The Cato Review of Business and Government, Spring 2002, Vol. 25, No. 1.

For pdf text (requires free Acrobat reader)


Browse more articles on Tax and Spending Issues