NCPA - National Center for Policy Analysis

Location-Efficient Mortgages More Costly And Risky

August 8, 2002

Americans appear to be more concerned about urban sprawl than crime or unemployment. To discourage sprawl, policymakers are using location-efficient mortgages (LEM). LEMs allow families willing to live in densely populated, transit-rich communities to obtain larger mortgages with smaller down payments than traditional underwriting guidelines allow. According to advocates, LEMs curb sprawl by making homes in "location-efficient" communities more affordable to low- and middle-income borrowers who would ordinarily live in less expensive fringe areas.

But LEMs may have more costs and risks than proponents claim. Researcher Allen Blackman found no demonstrable relationship between location efficiency and the probability of default. Thus 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 that the loans have a higher default risk.

Location efficiency does not reduce borrowers' default risk, says Blackman:

  • 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.
  • Estimates of transportation cost savings generated by the LEM computer model --often hundreds of dollars per month -- are overstated.
  • Real estate markets efficiently capitalize any financial benefits from location efficiency into housing prices -- such as the premium on houses close to a subway stop.
  • 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, Vol. 25, No. 1, Spring 2002, Cato Institute.

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