Opportunity Knocks: Socially Underwriting the Small-Dollar Mortgage
When Pinnacle Bank entered the Memphis market through their acquisition of Magna Bank, the community development team began to meet with community leaders. They kept hearing one thing over and over again: “We need a source for small-dollar mortgages. We have a lot of homes that are available for sale for less than $50,000, but we can’t find a lender that will make these mortgages.” The Pinnacle team immediately started to focus on how to get that money into the market. They worked with two nonprofits in the Memphis area to begin small-dollar mortgage pools. This is the story of one of those partnerships.
Home Loan Opportunity Fund
Pinnacle Financial Partners and The Works Inc. have formed a unique partnership to provide small-dollar home loans to low- and moderate-income (LMI) individuals. Many people, despite having acceptable credit and the ability to repay, find it difficult to obtain first-mortgage loans at all, let alone at reasonable rates. Given this reality, there is a tremendous need for a new solution in Memphis.
The current lack of availability of these loans is the result of a number of factors. Given their small-dollar amount, these mortgages offer financial institutions little return for the same level of underwriting effort and administration as larger loans that provide a greater return. These loans are often more difficult to underwrite than a typical larger-dollar transaction in more affluent communities with higher median incomes. The challenges for financial institutions in originating these small loans have also been exacerbated by the global financial crisis and resulting new regulation, some of which had the consequence of making it less likely that financial institutions would originate these types of mortgages. In a laudable effort to eliminate predatory lending, fees and closing costs are included in the calculation of the consumer’s effective interest rate. Because many of these costs are fixed (legal, appraisal, etc.), they are a larger percent of the smaller mortgage amount. Therefore, small-dollar loans may give the false impression of being predatory.
One solution is the partnership between The Works and Pinnacle. The Works is a long-standing not-for-profit organization with deep roots in the community and specific experience in mortgage loan origination, credit counseling and loan servicing. The organization became a nonprofit mortgage brokerage in early 2006 through their Safe Loans program. In February 2007, The Works was licensed as the first nonprofit mortgage brokerage in both Tennessee and Mississippi. In one year of operation, the Safe Loans program generated more than $1.2 million in total loans and received FHA certification. Unfortunately, this program was discontinued due to the global financial crisis. However, The Works gained valuable experience in the implementation and administration of an effective mortgage loan program.
As a pilot program, Pinnacle Financial Partners, the second-largest Tennessee-based bank, provided $500,000 in initial funding for the Home Loan Opportunity Fund. However, the intention is to expand the program with additional funding based on its success and market demand. Working directly with individuals, The Works will provide credit counseling and assist in the application process. The organization will also continue to be involved with mortgage clients as an ongoing resource. Pinnacle, in concert with The Works, will provide servicing for the loans that are originated.
Pinnacle’s initial investment financed the mortgage loan pool through Tennessee’s Community Investment Tax Credit program. The investment was priced at prime minus 4 percent, which resulted in the investment having an interest rate cost of 0.25 percent to The Works based on current rates. The investment has an initial term of seven years with automatic one-year extensions until otherwise notified by Pinnacle. Once notice has been provided, a repayment structure will be agreed upon and the loan set on an amortizing term note.
As payments are received on the individual mortgage loans, they will be applied to any interest due on the Pinnacle investment with the remainder contributed to the loan loss reserve fund. The reserve fund will be owned by The Works and pledged as collateral to the investment. The reserve fund was prefunded and maintained at a level of 10 percent of the outstanding mortgage loan pool. These funds are available to cover any actual losses incurred on the individual mortgages. Excess reserve funds are available to The Works to increase the program, cover operating costs or apply to other programs.
The Home Loan Opportunity Fund was officially launched in January 2017. Since the initial meeting with potential borrowers in January, 58 borrowers have applied, and the approval rate is 24 percent (14 loans). Applicant pre-approval loan amounts ranged from $35,000 to $50,000, with the majority receiving $50,000. The first two loans closed in late May 2017, less than six months after the program was initiated. The Works will maintain detailed information on the applicants and loan performance to build a case for small-dollar mortgages and to encourage CRA-qualified investment from other financial institutions into similar loan pools, expanding opportunity for LMI borrowers.