Julian Spector is a former editorial fellow at CityLab, where he covers climate change, energy, and clean tech.
Home loans haven’t covered the cost of buying and renovating a run-down house, so the city thought up something new.
Detroit has a lot of cheap housing, but much of it desperately needs renovations. Residents have avoided buying houses in the city, looking instead to rent or move to the more expensive suburbs. That’s partly because lending policies make it hard to get money to buy an old house and fix it up.
Banks peg the amount of a home loan to the appraised value of a house. When the house is in good shape, that’s all you need. But if the house has a low market value because the market itself has collapsed, or it requires extensive and costly repairs, the would-be buyer has to scramble to find renovation money elsewhere. That might mean racking up credit card debt, or delaying the work for months until some money can be found.
The city of Detroit is tackling this problem with a new lending program unveiled Thursday. Detroit Home Mortgage offers buyers a mortgage for the cost of the house, plus a second mortgage to cover up to $75,000 of repairs. The goal is to deliver 1,000 of those renovation loans over the next three years, at a fixed rate of 5 percent interest with no bank fees. Mayor Mike Duggan hopes this will spur homeownership in the city and kickstart a housing market that’s been languishing since the city’s financial troubles began.
“If you have a steady job and a good credit score, you can go in today… and you can get a mortgage regardless of the appraisal,” Duggan said at the announcement. “You can buy that house, you can have ownership.”
On its surface, the plan flies in the face of a core tenet of financial responsibility: don’t borrow more for your home than it’s worth. But the housing market in Detroit is such an anomaly that the traditional rules don’t always apply. For starters, the city’s mortgage market is nearly dead. Only 462 of the single-family homes sold in 2014 used a mortgage—that’s just 13 percent; almost all were cash transactions. For home purchases to reach a broad segment of the population, there has to be greater credit access for all the people who can’t pay cash.
Meanwhile, vacant homes are falling apart, succumbing to mold and the elements, not to mention scrap dealers snagging loose pipes or doors. Any purchase of one of those houses is contingent upon having the money to repair it.
“There hasn’t been, at scale, any type of loan product that would cover those repairs,” says Nick Salter, head of U.S. economic empowerment at the Clinton Global Initiative. “That’s what this new program does.”
Duggan raised the appraisal gap issue with the Clinton Global Initiative in January 2015, and CGI helped assemble a crew of partners to do something about it, including two national foundations, five regional banks, local mortgage counselors, and the Obama administration’s Detroit Federal Working Group.
In order to work, the program needed to lower the risks of lending. That’s where the Michigan-based Kresge Foundation comes in, offering $6 million to guarantee the renovation loans in the event that an unexpected hardship forces the owner to sell before their house reaches the value of the loan, says Kim Dempsey, deputy director of social investment at Kresge. Prospective buyers don’t have to worry that they’d be swamped in debt if they have to sell early, and lenders don’t have to worry about losing their money on an unconventional arrangement.
Detroit Home Mortgage includes several local counseling groups to advise buyers on the risks associated with the second loan and help them balance the debt. The long-term success of the program will hinge on how many of the buyers succeed in growing their home value and paying off the extra loans.
Detroit Home Mortgage also aims for a larger effect on the housing market by spurring new home sales to close the “appraisal gap,” says Frank Altman, president and CEO of the Community Reinvestment Fund, which oversees the pool of renovation mortgages.
Broadly speaking, appraisals for home sales compare the house to similar houses that have sold in an area recently. In Detroit, that process is skewed by a low volume of sales and and high number of decrepit properties. A nice house on a street full of abandoned and crumbling edifices will have a lower appraised value. A house in an area where the only recent sales have been bargain barrel foreclosure auctions will be similarly affected. This gap between the inherent value and appraised value of a home makes it hard to invest in one, because you could put $50,000 into improvements and see the appraisal budge far less than that.
The program’s 1,000 mortgages would mark a colossal influx for a market that’s used to a few hundred mortgages a year. In turn, as those new buyers improve their homes, they’ll nudge up appraised values for themselves and neighboring properties. “We need to start moving up the recorded values, so you start to move from a vicious cycle to a virtuous cycle,” Altman says.
If that happens, Salter notes, it will generate spillover effects beyond increased home ownership rates: vacancies in a neighborhood could decrease, local businesses could get more customers, and the local economy could benefit overall.
“If you get enough home transactions going, you’ll actually fix that appraisal gap over time,” Salter says. “This doesn’t need to be a permanent program—this is meant to correct a market failure.”