By Steven Sugarman and Carlos Salas
Underbanked populations in the United States are varied and diverse, both in their circumstances and in the specific challenges they face to secure access to the financial system. They can be urban or rural, they may be new arrivals or be burdened by historic discrimination, or they may suffer from challenging life events. But they are uniform in respect of being denied access to competitive loans and services. Unfortunately, newly announced rules for CDFIs threaten to codify the exclusion of underbanked borrowers from some of the most popular and useful home mortgage products available to mainstream bank borrowers. Moreover, the United States Department of the Treasury's new rules for CDFIs threaten to push any large-scale lenders out of CDFI lending altogether. These foreseeable harms are why the Treasury must provide waivers for responsible CDFI lenders to continue their missions.
The Treasury recently updated the rules and regulations regarding CDFI certification. These new rules come into effect in 2025 and require all CDFIs, including those that are banks and credit unions, to comply with new Responsible Financing Practices (RFPs) adopted by the Treasury in order to demonstrate their primary purpose is in fact community development. The rules also set forth a common-sense process to request modifications to the RFPs to address unanticipated negative consequences from their implementation.
The new RFPs are more restrictive than existing regulations promulgated by the Consumer Financial Protection Bureau (CFPB) and banking regulators, preventing CDFIs from offering loan products that are broadly offered by banks. As a result, creditworthy CDFI borrowers will be prevented from getting the same loans available to mainstream bank borrowers. For instance, CDFIs will be prevented from making interest only loans to creditworthy homeowners or offering streamlined refinancings to lower the interest rates on existing mortgages. While the intent of the restrictions appears to be consumer protection, the Treasury's overbroad approach would reinforce the status of underbanked populations as second-class borrowers unable to get the same loans available to bank borrowers.
Also concerning is the impact the new rules will have on the ability of CDFI lenders to provide services at scale. The new rules would pull the certification from a CDFI that offers restricted products to any borrower, mainstream or underbanked, no matter the suitability of the product to the customer. As a result, CDFI lenders would face the stark choice of operating as second-class lenders unable to offer otherwise popular loan products or abandoning their CDFI certification altogether. Either way, this would result in fewer lenders serving the underbanked with a full suite of mainstream loan products.
But this doesn't need to be the consequence of the new rules. While the new rules don't currently provide exceptions, CDFIs are offered the ability to request waivers from the Treasury's CDFI Fund to address unintended consequences. Waivers will play a critical role in ensuring that the proper balance is struck between consumer protection and fulfilling the CDFI mission of helping underbanked, underserved borrower receive the same banking and lending services that they would be offered by banks if they lived in a different community or came from a different background. It is imperative that the Treasury judiciously consider waivers for CDFI lenders to avoid negative impacts to underbanked borrowers.
The new blanket restrictions on interest only home loans are intended to protect consumers, but prohibiting CDFIs from offering interest-only loans responsibly and in instances when it is in a consumer's best interest is counterproductive to the CDFI mission. For instance, many credit-worthy consumers use interest-only loans to minimize the size of their home loans and seek loans well below the loan limit that they qualify to borrow. These consumers are benefitted by being able to reduce their interest expense and monthly payments by reducing their loan amount. This popular strategy rewards borrowers who pay down their mortgage balance instead of maximizing their debt. Often these same borrowers will elect an interest-only feature so that the timing of their debt repayment is in their control and they can reduce their outstanding loan amount as much as possible.
The Treasury's new RFPs that now prevent CDFIs from offering interest-only loans, will result in CDFI borrowers taking out higher loan amounts and incurring more interest expense in order to have cash reserves proportionate to their higher month payments. For instance, a borrower who would have otherwise sought a 50% Loan-To-Value (LTV) interest-only loan now might seek a 60% LTV amortizing loan to have the cash available to service the loan, given the greater debt service burden. Additionally, the lack of the interest-only feature reduces the consumer's incentive to pay down their loan as their monthly payment would not be reduced with the payoff, instead only the duration of the loan would be shortened.
Similarly, the RFPs add restrictions on CDFIs that could prevent them from providing streamlined refinancings of private mortgages. Researchers at MIT published a study showing that the average Black homeowner pays over $67,000 more in interest over their lifetimes due primarily to their inability to refinance their loans to lower rates when such refinancings are available to mainstream bank borrowers. CDFIs play a critical role offering these borrowers streamlined refinancings (at very low or no cost) when they can lower the borrower's interest rate and keep the rest of the terms of the loan identical. These streamlined refinancings allow homeowners who have paid their mortgages on time and demonstrated an ability to make their mortgage payments over time to lower their interest rate without having to go through the time-consuming and expensive process of a full new underwriting.
FHA and VA have extremely successful programs to refinance existing loans to lower rates without requiring verification of income or assets of borrowers who were fully underwritten as part of the initial loan and have made their payments. Bank borrowers benefit from similar streamlined refinance loans to lower their mortgage interest rates. CDFI borrowers, however, will no longer be able to receive a streamlined refinance from a CDFI as the new regulations require all loans to be more fully underwritten with the verification of the borrower's current income and/or assets prior to refinancing the loan. This requirement is unique to CDFIs, thereby driving up costs to the underbanked consumer of the new loan. Additionally, to the extent the borrower's current loan has an interest only feature, the CDFI lender is prohibited from offering the same borrower the same loan with just a lower interest rate. Instead, the borrower would need to relinquish their interest-only feature and incur higher monthly payments in order to get the lower interest rate that bank borrowers receive.
It is likely that the Treasury's CDFI Fund will ultimately provide CDFI's waivers that would enable CDFIs to continue to lend to underserved, underbanked homeowners responsibly. CDFIs should be allowed to offer the underbanked the same loans that non-CDFI banks are allowed to offer when such loans comply with all CFPB and banking regulations and are in a consumer's best interest. The current blanket prohibitions against interest-only loans and similar popular financial products fail to accommodate the diversity of the underbanked community and wrongly assume that underbanked borrowers all lack the sophistication to choose the product most suitable to their circumstance.
While the bulk of the protections and requirements placed on CDFIs by the RFPs are highly productive and welcome, a fundamental principle that should guide the RFPs is to ensure that CDFIs act responsibly and consistently with their community development missions while allowing CDFIs the flexibility to offer underbanked consumers the same loans, at the same terms, as those offered by banks to their borrowers.
xChange Inc., is a subsidiary of The Change Company CDFI, America's largest Non-QM lender. The Change Company seeks to expand homeownership by providing credit-worthy loans to prime, underbanked borrowers and is licensed to lend in 48 states.
