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Profit Published by the Consumer and Community Affairs Division The Federal Reserve Bank of Chicago Volume 10 Issue 1/ Winter 2000 MCAP’S continuing role IN ENSURING FAIRNESS IN MORTGAGE LENDING [ LENDING ] PREDATORY ALSO IN THIS ISSUE: CEDRIC: A New Web Resource Core City Neighborhoods Financial Markets Use By Black Households Profit The Profitwise welcomes story ideas, suggestions, and letters from all bankers, community organizations and other subscribers in the Seventh Federal Reserve District. It is mailed at no charge to state member banks, bank holding companies and non-profit organizations throughout the Seventh Federal Reserve District. Other parties interested in neighborhood lending and community reinvestment may subscribe, free of charge, by writing to: In this Issue Profitwise Consumer & Community Affairs Division Federal Reserve Bank of Chicago P.O. Box 834 Chicago, IL 60690-0834 The material in Profitwise should not necessarily be interpreted as the official policy or endorsement of the Board of Governors of the Federal Reserve System, or the Federal Reserve Bank of Chicago. Advisor 1 MCAP’s Continuing Role in Ensuring Fairness in Mortgage Lending 10 Introducing a New Web Resource 12 Core City Neighborhoods 16 The Use of Formal and Informal Financial Markets Among Black Households 24 Seminar Calendar Alicia Williams Editor Michael V. Berry Assistant Editor Jeremiah Boyle Design Recycled Paper Graphic Services MCAP’S continuing role IN ENSURING FAIRNESS IN MORTGAGE LENDING MICHAEL V. BERRY MCAP Program Manager, Federal Reserve Bank of Chicago NISREEN DARWISH MCAP Project Coordinator, Federal Reserve Bank of Chicago T he Mortgage Credit Access Partnership (MCAP) is a program developed by the Federal Reserve Bank of Chicago, which was co-convened with six other organizations in 1996. The purpose of MCAP is to promote fair treatment in the home purchase and financing process. Over 100 organizations registered as MCAP Partners, many of which were instrumental in developing and implementing key recommendations to stem unfair practices and policies. (See the Winter 1997 and Winter 1999 editions of Profitwise for previous articles on the Mortgage Credit Access Partnership program.) [ LENDING ] PREDATORY 1 The problem is greatest, and the practices most prevalent, within the most vulnerable populations, according to recent reports by both the National Training and Information Center and the Woodstock Institute, both MCAP Partners. Predatory mortgage lenders engage in aggressive marketing efforts directed to low-income, minority communities. Predatory lenders often target individuals who are financially distressed, but who have accumulated considerMCAP has recently turned its attention to the issue of able equity in their home. These consumers may have fallen predatory mortgage lending. While there are a number of behind on medical bills, property taxes, or other expenses lending practices considered “predatory” by watchdog and they face barriers, real or perceived, obtaining unse- groups, the effect on borrowers is similar: they pay much cured credit. The result is they access equity in their homes more for mortgage credit than they can afford to pay, or to meet their financial needs. To the extent that low-income, their risk profile warrants, and often lose their main asset, minority communities are targeted, these practices are (i.e., their home), as a result. Due to the efforts of organiza- especially damaging from an economic perspective. Com- tions such as the Atlanta Legal Aid Society, the National munities already economically disadvantaged are subjected Training and Information Center, the Legal Assistance to a further destabilizing influence, as homes are foreclosed Foundation of Chicago, the Woodstock Institute, and other and often left abandoned, and residents lose their primary, consumer advocates, the issue is now high on the agenda and sometimes only, source of household wealth. of various government agencies and lawmakers. [ 2 Predatory lenders are ones that “target a particular population, take advantage of the borrower’s inexperience and lack of information, manipulate a borrower into a loan the borrower cannot afford to [re-]pay, or defraud the borrower...often these tactics are directed at a particular population, most frequently the elderly and low-income minorities, that is viewed as more vulnerable...” From: “Understanding Predatory Lending: Moving Toward a Common Definition and Workable Solutions,” Neighborhood Reinvestment Corporation, October 1999 ] The Federal Reserve Bank of Chicago has led an MCAP task group examining the issue of predatory lending since December 1998. On March 30, 1999, the committee held an informational meeting at the Federal Reserve Bank of Chicago with representatives from the Iowa and Illinois Attorney General Offices, the Federal Trade Commission, the [ CONVENTIONAL, SUBPRIME VERSUS PREDATORY LENDING ] Federal Reserve Board, the Legal Assistance Foundation of Chicago, the Illinois Office of Banks and Real Estate (OBRE, the state regulator for mortgage brokers and bankers) and It is important to recognize the differences between main- the Illinois Association of Mortgage Brokers. The purpose stream, conventional lending methods and predatory lend- of the meeting was to present several case studies high- ing practices. lighting the most egregious practices, to discuss enforcement A predatory lender is not necessarily interested in actions, and to provide an overview of proposed regulatory the credit worthiness of a borrower, as long as the borrow- reforms. In June 1999, the MCAP task group held a joint er has sufficient equity in his home to cover the mortgage meeting with a predatory lending task force organized by amount. The “mortgage amount” includes money disbursed Neighborhood Reinvestment Corporation, which subse- to the borrower, money used to settle existing debts, or quently prepared a paper entitled: “Understanding Predatory both, plus points, fees and potentially credit life or disability Lending: Moving Toward a Common Definition and Workable insurance premiums. Often, lenders engaging in predatory Solutions,” October 1999. practices insist that the credit insurance premiums be paid The Chicago Fed’s task group has done comprehen- in full at closing and financed into the loan, which has the sive research on pending or newly enacted state legislation added effect of inflating the mortgage amount and points around the country to fight predatory lending. Two commit- associated with the transaction. Credit life and disability tee members, the National Training and Information Center insurance policies can be very high cost, and generally are and the Woodstock Institute, are spearheading efforts to of little or no use to a borrower, since he is most likely to introduce legislative reforms in Illinois. Groundbreaking refinance the loan or ultimately lose his home through fore- legislation that prohibits certain practices, including the closure. In either of these instances, the insurance policy financing of points and fees above specified pricing trigger simply expires and the premiums paid are lost. points, has already been enacted in North Carolina and proposed in New York. For the average middle- and upper-income borrower, damaged credit or not, the credit marketplace is highly competitive, and the marketplace regulates the rates and terms of mortgage loans. “Lower income communities tend not to have as many traditional lenders, and prime lenders do not aggressively market to these areas,” according to Dan Immergluck of the Woodstock Institute. “In the subprime market, borrowers are not as diligent in shopping around for rates, so competition is not effective as a means to keep pricing within reason.” 3 While the terms “subprime lending” and “predatory lending” are often used interchangeably, there is an important distinction. The Federal Reserve and other bank regulators consistently urge banks to price for risk within their lending guidelines. It is understandable that subprime lenders charge more (fees and interest) for a loan to compensate for higher levels of risk, consistent with a borrower’s credit history. All subprime lending is not necessarily harmful in that it increases availability of credit for higher risk borrowers. There is movement within the GSEs, government sponsored [ SPECIFIC PREDATORY LENDING PRACTICES ] enterprises, Freddie Mac and Fannie Mae, to establish a secondary market for subprime mortgages, which would Many of the abusive and predatory lending practices were create readily identifiable underwriting standards where identified by William J. Brennan, Jr., Director, Home Defense there is a good deal of variability presently. A subprime Program of the Atlanta Legal Aid Society, Inc., in his state- mortgage gives a borrower with blemished credit an oppor- ment before the United States Senate Special Committee on tunity to repair his credit history by making steady payments Aging on March 16, 1998. on a higher rate mortgage and later applying for a loan with more competitive pricing. When high fees and points AMONG THE MOST HARMFUL PRACTICES IN TERMS OF are combined with a high interest rate, the borrower is sim- COST TO BORROWERS ARE: ply giving away a substantial amount of equity, and the loan • Excessively high points and APR (annual percentage rate) is likely not serving the borrower's interests. for the credit risk posed by the borrower. Points are usually charged to borrowers who want to buy down the interest rate on the loan. Predatory lenders, however, charge high points with no corresponding reduction in the interest rate. The points are typically financed into the loan, causing the amount borrowed and interest paid to increase as well. • Frequent refinancing, commonly referred to as “flipping,” of one high-cost loan, usually to a new, even higher cost loan. • Lending to people who simply cannot afford to repay, a practice often facilitated by falsifying income sources and amounts to the funding lender, and thereby virtually guaranteeing default; 4 • Negative amortization: a loan where the monthly payments • Home improvement scams: Contractors, acting as loan are not sufficient to pay down principal and interest, and brokers, are used to solicit business. The home improve- accordingly the loan balance increases over the loan ment company originates a mortgage loan to finance the term, so that at the end of the loan term, the entire prin- home repairs they offer and then steer the homeowner cipal amount plus accrued interest is due, triggering directly to the lender. The home improvement work is either default or a refinancing. (A negatively amortizing often of poor quality and very high cost. loan is not exclusively a predatory loan, although there are only limited circumstances where a negatively amortizing loan is appropriate, such as in a rapidly appreciating real estate market. In the context of predatory lending, it is used with a borrower likely unaware that his/her debt is increasing rather than decreasing, ostensibly to leverage a low-income household into a larger note than would otherwise be possible). • Steering to higher cost loans: Some banks and mortgage companies steer customers to high-rate lenders even when a borrower qualifies for a lower-cost loan. Kickbacks and/or referral fees are paid to the loan originator as an incentive. Similarly, borrowers who apply with a subprime lender, but qualify for prime mortgage rates, are not referred to a prime lender or product, even if the prime lender is an affiliated company. SOME OF THE SALES AND MARKETING TACTICS USED BY PREDATORY LENDERS INCLUDE: • High pressure solicitations: Loan originators engage in extensive marketing in targeted communities. They advertise through commercials, signs, telephone solicitations, flyers, and direct mail. (Lenders can legally obtain from the national credit bureaus lists of borrowers with specific criteria in their credit report that suggest they may be candidates. You may have seen in your own mail what looks like an official document from the Social Security Administration or some other government agency, only to find upon opening the envelope that is a “check” from a home equity lender indicating a loan amount that you’ve been pre-approved to borrow. Certainly not all direct mail solicitations from home equity lenders are from ones looking to overcharge consumers, but it is a common marketing tactic among predatory lenders, as is door-to-door canvassing.) 5 [ A CASE STUDY IN PREDATORY MORTGAGE LENDING ] The story of Robert Jackson, a victim of predatory mortgage Mr. Jackson fell behind on his loan payments and in lending, illustrates many of these abuses. Mr. Jackson is March of 1996 applied for a second loan for the amount of ninety-one years old. He is black, a widower, and living on $39,000 to refinance the original $20,000 loan. Despite the Social Security income. He retired in 1974 and bought his increased mortgage amount, he received very little cash current home with his wife three years later from the U.S. out of this loan, as he had accrued interest and penalties Department of Housing and Urban Development (HUD) for associated with the initial loan. Not surprisingly, Mr. Jackson $4,200. Prior to her death in 1993, Mrs. Jackson handled all rapidly fell behind on this loan as well. He received many of the household finances and had paid off the mortgage on phone calls, letters, and house calls from numerous mort- their home. gage brokers, anxious to extend him a new loan. The princi- After Mrs. Jackson’s death, having not had any recent pal balance of his loan of $39,000 had, because of his missed experience managing the household finances, Mr. Jackson payments and the resulting accrued interest and penalties, found himself behind on his bills. In addition to being in debt increased substantially. In June of 1997, Mr. Jackson for his wife’s burial, he fell behind on his property taxes, and applied for another loan for the principal amount of $51,750 his roof needed repair. His wife had also left a $6,000 credit as means to pay the balance on the previous loan, a heavy card balance behind. In August 1994, Mr. Jackson borrowed origination fee, and assorted other costs. Again, Mr. $20,000 using his home equity as collateral. He learned Jackson was delinquent very quickly and defaulted in the about the lender from a home improvement contractor who spring of 1998, according to his recollection. had offered to repair his roof. With this amount, he was able to pay off some of his balances and have repairs done to the roof, although Mr. Jackson notes, “they did not do a good job.” Ira Rheingold, an attorney with the Legal Assistance Foundation of Chicago representing Mr. Jackson in his current foreclosure proceedings (several refinancings later), adds that the contractor was one with “a poor performance record that acts as a bird-dog for many lenders.” 6 In August 1998, Mr. Jackson was contacted via a mail Mr. Jackson’s only steady income is his Social solicitation by a lender promising him an “affordable” loan Security benefit of $795. He occasionally rents out the lower to pay off his existing mortgage plus provide him at least level of his house for about $400 on a month-to-month basis, $3,000 in extra cash. At the closing on September 18, 1998, although it is not a steady source of income for him. Mr. Jackson was surprised to find that he was being Inevitably, Mr. Jackson defaulted on the loans, and at the extended two loans. However facing foreclosure, he was time of our interview was in foreclosure. not inclined to call off the transaction. One loan was for the “Mr. Jackson’s situation is not unique; we see these principal amount of $64,350 with an Annual Percentage Rate cases involving the elderly every day. Lenders’ assertions (APR) of 14.095%. The loan was a 30-year adjustable rate that they are providing a good service to borrowers who mortgage in which Mr. Jackson was required to make initial cannot obtain credit from conventional sources are spuri- payments of $699.29, but the payment did not include amounts ous from my experience,” said Mr. Rheingold. “Most elderly for taxes and insurance. The second mortgage agreement victims, like Mr. Jackson, feel more exploited than helped. bore a name of a different mortgage brokerage firm than Instead of enjoying their retirement years spending time the one that originated the first loan, but shared the same with their grandchildren or just relaxing, they are struggling address as the lender on the larger mortgage. The second to save their homes from foreclosure and themselves from loan amount was $4,200 with an interest rate of 15%. Under homelessness, since they don't have other assets to fall the terms of this loan, a 30-year fixed rate mortgage, Mr. back on.” Jackson was to pay $53.11 per month. Mr. Jackson received no funds in connection with the second loan and he believes that the loan proceeds went entirely to the loan originator (broker). He paid over $4,400 in fees on the larger loan, and he paid for separate appraisals for the two loans, which closed at the same table on the same day. Mr. Jackson had received loans totaling $68,550 and was required to make monthly payments of $752.40, which again did not include his taxes and insurance. Every six months, Mr. Jackson’s rate for the larger of the two loans would adjust by the London Interbank Offered Rate (LIBOR, 6.195% at the time of this writing) plus 8.25%, but never less than 12.75% or greater than 19.75%. 7 A BROADER PERSPECTIVE OF THE ISSUE “The additional cost of a high rate mortgage can make a ‘high risk’ loan a self-fulfilling prophecy because the higher costs become the fuel for failure...many of the high cost loans provided to low income borrowers appear to have debt to income ratios designed to create default, or force refinancing of the loan...,” said William J. Brennan, Jr., Director, Home Defense Program of the Atlanta Legal Aid Society, Inc., in his statement before the United States Senate Special Committee on Aging on March 16, 1998. “It is significant that foreclosures have increased by approximately 300% since 1980. These numbers do not include the thousands of homes which are turned over to lenders voluntarily (called deeds in lieu of foreclosure) or are sold for less than their value to avoid foreclosure. The bottom line is millions of Americans are losing their homes because of unaffordable home mortgages.” [ [ 8 ] ] Dan Immergluck, a researcher and Senior Vice President of the Woodstock Institute, offers some opinions, as well as key statistics from the paper, “Two Steps Back: The Dual Mortgage Market, Predatory Lending, and the Undoing of Community Development,” which Woodstock released in November 1999: “The explosion of the subprime mortgage lenders, who dominate refinance and home equity lending in minority neighborhoods, and the failure of regulation to adapt to this industry has left us with a two-tiered, race-based mortgage system. The lenders serving minority neighborhoods are largely unregulated, while the banks and thrifts serving non-minority, more affluent communities are heavily regulated. In 1998, in the six-county Chicago area, subprime lenders accounted for 74% of refinance applications and 58% of loans in predominantly African-American neighborhoods, compared to only 21% of applications and 10% of loans in predominantly white communities. Of the 20 lenders accounting for the most refinance applications in African-American neighborhoods, all but one are subprime firms. In predominantly white neighborhoods, all but three of the 20 leading marketers of refinance loans are prime lenders.” ADDRESSING THE ISSUE IN ILLINOIS AND NATIONALLY Home ownership has long been recognized, and used, as a means to build wealth and stability in lower-income communities. Through pressure from community groups, and due to the obligations of banks under the Community Reinvestment Act, home ownership has increased among households that under traditional guidelines would not qualify for mortgage financing. The increase has occurred through the development and use of creative financing tools and by devoting significant public resources to this goal. Absent reforms, advocacy groups predict that predatory lending practices will reverse much of the growth in home ownership in communities where wealth building and economic growth is most needed. In Illinois, the National Training and Information Center, the Woodstock Institute and other concerned groups have met with mortgage lending trade associations to discuss the issue and to build industry support for reasonable and fair legislative reforms. This past October in Illinois, State Representative Daniel Burke held a hearing at the James R. Thompson Center in Chicago. Members of the Illinois legislature and others interested in the matter heard personal accounts from victims of predatory lending and discussed possible changes to Illinois law to prevent further abuses. Mr. Burke introduced a bill addressing the issue in the January 2000 legislative session. The National Association of Attorneys General (NAAG) has a predatory lending subcommittee with 20 states plus the District of Columbia represented. Tom James, of the Illinois Office of the Attorney General and a member of the subcommittee, noted that “under current laws, cases involving mortgage lending violations must be prosecuted on an individual basis, using a wide range of very mixed and often contrasting objective and subjective factual and legal tests, standards and criteria, which is a very inefficient way to address the problem.” To have real impact, Mr. James concludes “would require legislation that gives us a clear definition of a high-cost loan, and enforcement power to address price gouging, insurance packing, flipping (frequent refinancing to new high-cost loans) and other practices, possibly with increased penalties for infractions involving the elderly.” The NAAG subcommittee is working toward recommendations on national legislative reforms. The Fed’s MCAP predatory lending task group intends to issue its recommendations by the second quarter of 2000. Future issues of Profitwise will cover the task group’s recommendations and efforts to implement them. The MCAP Partnership Report and the MCAP Summer 1999 Update are available to readers of Profitwise and others by contacting the Federal Reserve Bank of Chicago, Consumer and Community Affairs Division, at (312) 322-8232. 9 e are pleased to announce a new web site that offers a wealth of information to assist researchers, community development professionals, non-profit organizations, financial institutions, and government agencies. It’s called the Consumer and Economic Development Research and Information Center (CEDRIC). Its principal mission is to foster research related to consumer and economic development issues such as consumer and small business financial behavior, access to credit, affordable housing, and community development and reinvestment. Created and maintained by the Federal Reserve Bank of Chicago, CEDRIC has a research repository that includes abstracts of research studies as well as full text articles, reports, working papers and other studies generated by Federal Reserve researchers and analysts as well as academicians, government W agencies, and non-profit organizations. CEDRIC also provides a subject listing describing research included in the repository; announcements of upcoming events; a collection of valuable data resources; a glossary of community development terms; and links to CEDRIC partners. CEDRIC is a comprehensive research tool designed to help economists, analysts and other professionals identify consumer and economic development related research. It includes a Glossary of Community Development Terms, covering a wide array of relevant terms and concepts. For terminology beyond the scope of this web page, the user is directed to a variety of other online glossaries, including a Glossary of Consumer Credit Terms and a Glossary of introducing a newWE CEDRIC’S REPOSITORY SUBJECT LISTINGS ARE HIGHLIGHTED BELOW: Community and Economic Development Investment/development, urban stability, empowerment/enterprise zones, rural/agricultural issues, community development centers, and inner city rejuvenation; Consumer Financial Behavior Access to credit, consumer wealth, mortgage delinquencies, mortgage defaults, credit delinquencies, credit defaults, bankruptcy, culture and credit, income distribution, and alternative financial services; Housing Mortgage lending, location preferences, appraisal process, homeownership patterns, private mortgage insurance, and housing search process; Indian Reservation Development Affordable housing, community investment, legal considerations, access to credit, and banking services; Institution Behavior Branch banking, credit scoring, fair lending, redlining, affordable/low-income housing, profitability and regulations, homeowner insurance, pricing of credit, geographic patterns, financing alternatives, CRA, re Financial Regulators and Institutions. In addition, CEDRIC highlights high-quality, reliable online data sources. Drawing upon the data collection and analysis expertise of the Chicago Fed’s Consumer Issues Research Unit, we have provided a brief description about the numerous electronic databases and information systems, encompassing the fields of statistics, econometrics, economics and finance. ECOA & FHA activities, GSE & FHA activities, secondary market underwriting and minority-owned institutions. Small Business Entrepreneurship, failures, minority/women issues, lending, financing, and development. Two search options have been developed to provide CEDRIC users with an efficient way to retrieve relevant information. One can conduct a quick search by clicking on one of the six major subject areas located on the Repository Subject Listing page to view all of the documents related to that subject. Similarly, one can perform a focused search by specifying keyword(s), author(s), and/or title information. CEDRIC also serves as a forum for sharing relevant information about unique projects, initiatives, and events taking place across the nation. Currently, CEDRIC features an academic conference, Business Access to Capital and Credit, hosted by the Community Affairs Departments of the Federal Reserve System on March 8-9, 1999 in Arlington, Virginia. CEDRIC offers easy access to the complete conference proceedings, which includes papers and summaries of the papers presented by distinguished economists and scholars from across the country. These proceedings are designed to further the understanding of small business lending and credit issues among B source Consumer and Economic Development Research and Information Center (CEDRIC) scholars, practitioners, and policymakers. Furthermore, the Events page announces relevant upcoming conferences, seminars, forums, and workshops taking place across the country. Finally, CEDRIC users are encouraged to contribute to the site’s database by submitting relevant publications, articles, abstracts, working papers and other studies. By utilizing a user-friendly Submission Procedure interface, researchers and analysts have the opportunity to share valuable information with CEDRIC’s ever-expanding audience and, thus, foster future research on the topics related to consumer and economic development. To date, CEDRIC has established partnerships with over 60 organizations, including academic journals, non-profit organizations, professional associations and government agencies. You can learn more about CEDRIC’s partners by visiting the Partner Listing page, which includes contact information as well as website links. Visit CEDRIC located on the Federal Reserve Bank of Chicago’s public website at www.frbchi.org by following the ‘Community Development Research Center’ link listed under ‘Resources.’ For further information, please contact CEDRIC’s coordinator at cedric@chi.frb.org. 11 “If you want to move people, it has to be toward a vision that’s positive for them, that taps important values, that gets them something they desire, and it has to be presented in a compelling way that they feel inspired to follow.” – Dr. Martin Luther King, Jr. c o r e c i t y NEIGHBOR- HOODS a dream fulfilled – empowered to build C ore City Neighborhoods (CCN) has always been a express their ideas and interests regarding the community. community-based organization. The seeds of the It was from this sharing of a common vision that Core City organization were planted in 1984 by four women who began asking some fundamental questions about neighbor- Neighborhoods began to take shape. In the spring of 1985, a steering committee consisting hood empowerment. Together, Sr. Theresa Blaquiere, of residents, business people and other community groups Shirley City, Almena Jones and Bernice Richmond began representatives was formed. Participants shared their sharing their hopes and visions for the community. From vision of community and economic development. Boundaries their early organizing effort, CCN’s mission gradually began were established for the neighborhood to encompass a 3.5 to unfold. As the four women walked door-to-door talking to square mile area. The geographic area served is comprised the residents and businesses in the area, people started to of an area of west Detroit between West Grand Boulevard, 12 Today, CCN remains a community-driven, membershipbased organization which engages its community members in a decentralized form of planning and decision-making. Proud of its strong community cohesiveness, tradition and to the north and west, Michigan Avenue to the south to I-96 values, the people who live within the community’s bound- and Martin Luther King, Jr. Boulevard to the south to Grand aries maintain a strong sense of community identity and an River Avenue and Rosa Parks Boulevard to the east. The equally strong willingness to create positive trends within community and economic agenda for the new organization the neighborhood through CCN’s resources. included housing advocacy and small business retention as Since 1997, CCN has been headed by Executive well as crime preven- Director, Joyce Rhyan. tion, training and job Ms. Rhyan brings 12 creation. Along with the years of experience in physical and economic urban planning, urban revitalization agenda, a design, historic preser- social and human devel- vation, redevelopment opment component sur- planning and neighbor- faced as an essential hood planning to the part of CCN’s mission. organization. Ms. Core City Rhyan has been a Neighborhoods was major force in helping incorporated in 1985, the organization fulfill and an 18-member its dream through the board of directors was refinement and imple- elected to govern the mentation of existing organization. A 12-mem- plans. ber housing board and 3 Ultimately, the subsidiary non-profit mission of Core City housing corporations were established to oversee housing Neighborhoods is two-fold. The first is to strengthen the activities. From the beginning, CCN’s ability to attract volun- social and human development of the community and its teers from the neighborhood and the business community residents. The second is to stimulate physical and economic was a major strength. By 1992, the number of staff members development of the area. had expanded to 18 and CCN had established itself as one of Detroit’s leading community-based organizations. The organization’s mission soon included a housing arm that managed four multi-family apartment buildings, a landscaping business able to secure and manage contracts with the City of Detroit, a community outreach and organizing arm, and an elaborate youth and family program. 13 industrious project to date. Construction of the apartment complex began in February 1998 and was completed in April 1999. This new multi-family development includes 12 buildings which house 121 units. The development occupies 11 acres, and consists of 12 one-bedroom, 84 two-bedroom Social and Human Development and 24 three-bedroom units. This rental property targets CCN’s social and human development includes community low- and moderate-income residents with a maximum organizing and outreach, as well as adult and youth leader- income of 60 percent of the area’s median income level. ship development. These efforts often focus on encouraging Alberta W. King Village was developed by Core City residents to take action together for the purpose of building Neighborhoods in partnership with the Michigan State community ties while meeting a concrete need in the Housing Development Authority (MSHDA), the National process. Current programs and services include parenting Equity Fund (NEF), the Local Initiative Support Corporation classes, youth programs and block club initiatives. (LISC), Comerica Bank and the City of Detroit. Physical and Economic Development The physical and economic development agenda for CCN includes housing services to private property owners, housing development, small business retention and development, crime prevention and new efforts in training and employment. The total development cost of the Alberta W. King Village apartment community was approximately $10 million, and it is the largest residential development constructed by a community-based nonprofit development corporation in the Detroit Empowerment Zone, the City of Detroit and the State of Michigan. CCN’S ACCOMPLISHMENTS Housing Acquisition and Rehabilitation Housing Development To preserve good housing stock and to increase the actual One CCN neighborhood, The Martin Luther King, Jr. rede- number of units, a CCN strategy has been to purchase high- velopment area, has been the focus of a major ongoing ly visible multi-unit residential properties which serve as an planning effort. The 300-acre site, located within Detroit’s anchor and a catalyst for further housing development. Empowerment Zone, is bounded by the Jeffries Freeway to Since 1989, CCN has purchased and renovated four build- the west, the Ford Freeway to the north, Grand River to the ings which house 52 units, valued at $2 million. east, and the namesake street, Martin Luther King, Jr. Boulevard, to the south. A preliminary analysis of this area by CCN indicated In addition, CCN has gained experience by managing and leasing two multi-family apartment buildings under its ownership. Its Property Management Division has made that, of 5,269 housing units, 829 were vacant and much of significant improvements to these properties. Local job the remaining housing stock was in fair or poor condition. creation and related forms of economic development within The City of Detroit owned approximately 50% of the total the neighborhood are the types of favorable results that land in this area. Commercial development within the local are spurred by these housing-related activities. area had been sporadic. Many buildings had been abandoned. In addition, according to 1990 census information, this area is considered to be a low-income area with over 53% of its residents having income levels below the poverty line. Within The Martin Luther King, Jr. redevelopment area, the Alberta W. King Village apartment community, named in honor of the civil rights leader’s mother, is CCN’s most 14 Minor Home Repair The Minor Home Repair Program is a Community Development Block Grant funded program through the City of Detroit. CCN is in its tenth year of administering this program in the Core City area. The program, which targets low-income homeowners in need of structural improvements, was augmented by a grant from the Federal Home Loan In summary, to paraphrase a letter sent to CCN residents Bank of Indianapolis and made available through an arrangement with Standard Federal Bank. As of 1998, by Executive Director Rhyan, “much has been achieved $667,010 had been expended in the repair of homes in the CCN area under the Minor Home Repair Program. since CCN was established 15 years ago. The organization Landscaping/Weed and Debris Removal Service CCN’s economic development activities include a Landscaping / has made substantial progress in a number of key areas. Weed and Debris Removal Service which provides jobs for difficult to place persons, as well as individuals receiving Nowhere was that realized more than when construction public assistance. CCN is the first community based organization to receive a weed and debris removal contract from was completed at the site of the new Alberta W. King the City of Detroit and Wayne County. The organization currently is responsible for the maintenance of approximately Village Apartment Community in April 1999. As a result, 10 million square meters of land per year. the City of Detroit, the State of Michigan and the nation Crime Prevention CCN mobilizes residents to secure and protect their invest- have an inspiring new model to follow. But perhaps most ments. Patrols, auto etching, and watch programs have been excellent prevention tools. Funding by the Automobile importantly of all, the residents of our neighborhood once Theft Prevention Authority and the City of Detroit Block Grant has enabled CCN to provide an etching program and again saw the rebirth of new, modern and affordable education related to automobile theft prevention. In addition, CCN has provided several workshops aimed at reduc- residential housing.” ing auto theft and other crimes. FUTURE PROJECTS AND PROGRAMS CCN plans to continue its development projects within the Martin Luther King, Jr. Redevelopment Area during the coming year. By mid-year 2000, CCN plans to begin construction on Phase 2 of the Alberta W. King Village. Phase 2 will be funded by MSHDA and result in 75 additional lowincome housing rental units. In addition, CCN plans to begin construction of a 45,000 square-foot neighborhood shopping center that may house amenities such as a drug store, hardware store, restaurant, laundry center and other facilities. The cost of the two projects is expected to be $8 million and $4.1 million, respectively. 15 THE USE OF Formal and Informal FINANCIAL MARKETS among black households 1 Sherrie L.W. Rhine, Manager and Economist and Maude Toussaint-Comeau, Economist Consumer and Community Affairs Division Federal Reserve Bank of Chicago 16 OVERVIEW OF FINANCIAL MARKETS SUMMARY fundamental understanding of consumer financial behavior is necessary for the development of effective policy. The paucity of information about the financial choices made by minority households prompted the Federal Reserve Bank of Chicago to conduct a unique survey in Chatham, a predominantly Black community in the City of Chicago. This article documents the use of banking products and services, the patronage of alternative financial service (AFS) businesses and the role of informal financial markets in this community. These findings are offered to fill some of the information gaps and to encourage additional research about the use of formal and informal financial markets within minority communities. The survey found that roughly one out of every five households is without a checking and/or savings account. Check cashing outlets and currency exchanges (AFS businesses) are patronized by the majority of households in the survey.2 Interestingly, these businesses also are patronized by over half of all households with a pre-existing relationship with a bank. By comparison, informal financial networks appear to play an important role among households who either are faced with financial distress or in need of additional financial assistance in purchasing a home. A A household gains several advantages from holding a deposit account with a financial institution. In terms of time and actual expense, payments for personal transactions often can be made at a lower cost. Households are shielded from risks associated with holding uninsured cash reserves and are availed with approximately 20 consumer protection laws and regulations safeguarding individuals from unfair, discriminatory and predatory lending practices. (Board of Governors of the Federal Reserve System, 1997). Despite the potential benefits from holding a deposit account, a large number of households remain unbanked, especially among lower-income or minority families. For example, Hogarth and O'Donnell (1997) find that almost 37 percent of all U.S. Black households are without either a checking or savings account. Among White households, however, they determine that less than 8 percent fall into this category. To meet financial transactions and credit needs, unbanked households often rely on check cashing outlets, currency exchanges or pawn shops (Swagler, et al., 1995). The cost of these alternative financial services has been shown to be almost twice as large as comparable banking services offered in the formal financial markets (Green and Lechter, 1998). As evidenced by the increase in class action lawsuits against major check cashing companies for alleged full disclosure violations, it is unclear that consumers patronizing AFS businesses are adequately protected against unfair lending or predatory business practices (e.g., Chicago Sun-Times, 1999). As pointed out by Bond and Townsend (1996), credit services can be provided by a diverse set of institutions ranging from informal networks of family, friends and social organizations to mainstream financial markets. Informal networks provide relationship-based financing often predicated on criteria different than formal financial markets. Cost advantages in information gathering, ability to utilize effective enforcement mechanisms and potential willingness to share greater risks related to implicit or explicit credit contracts are factors associated with informal markets unlikely to be present in formal financial markets. Informal networks also may be particularly well suited as a source of shortterm or small dollar amount financing often unavailable from formal sources. 17 SURVEY DESCRIPTION AND RESULTS Chatham was chosen as the site of this study because it is a distinct and well-recognized ethnic neighborhood. Located on the south side of the City of Chicago, Chatham became predominantly Black during the 1950s (Chicago Fact Book Consortium 1995). The Federal Reserve Bank of Chicago conducted the survey in Chatham between 1997 and 1998.3 The fieldwork resulted in the completion of 194 randomly selected household interviews. Based on the survey, median family income in 1996 was $35,000, classifying Chatham as a middle-income community. A household’s link to the formal financial market is captured through information collected about the use of a checking and/or savings account, various investments and longer-term savings accounts, and holdings of various loan products. Table 1 highlights the use of these financial instruments by household income to ascertain whether this relation varies at different income levels. As shown, 79 percent of all respondents reported having a checking and/or a savings account. The proportion of households using a checking and/or a savings account increases from 58 percent among households in the lowest income quartile to 92 percent of the households at the highest income levels. By contrast, 21 percent of the respondents had neither a checking nor a savings account. The proportion of TABLE 1 FORMAL FINANCIAL SOURCES BY HOUSEHOLD INCOME QUARTILE households without a checking and/or savings account decreases with household income from 42 percent of households in the lowest income quartile to 7 percent among those in the highest income quartile. Respondents did not make wide use of homerelated financing during the previous five-year period. While the age profile of this community (relatively older population) may have contributed to the lackluster activity in these credit markets, it remains unclear that life-cycle effects alone can fully explain the level of credit activity observed. As shown in Table 1, 9 percent of all households had a home mortgage or refinance loan, 6 percent had a home equity loan, and 3 percent had a home expansion loan over the previous five-year period. Car loans were the most frequently reported loan type, ranging from 8 percent among households at the lowest income quartile to 45 percent of the households at the highest income quartile. Finally, almost 50 percent of all respondents held at least one credit card, reaching 72 percent of all households in the highest income quartile. Total # of Households Percent of Sample 1st Income Quartile 2nd Income Quartile 3rd Income Quartile 4th Income Quartile 153 121 126 41 36 79% 62% 65% 21% 19% 58% 23% 42% 42% 8% 82% 64% 64% 18% 13% 84% 71% 71% 16% 24% 92% 85% 85% 7% 35% 95 18 11 6 10 6 50 49% 9% 6% 3% 5% 3% 26% 16% 3% 0% 3% 3% 0% 8% 31% 8% 8% 0% 10% 0% 23% 60% 18% 8% 3% 10% 3% 29% 72% 15% 10% 7% 2% 10% 45% 194 100% 24.5% 25.2% 24.5% 25.8% Financial Instruments Checking and/or Savings Accounts Checking Account Savings Account No Checking or Savings Account CD, IRA, Mutual Funds, etc. Credit Accounts – Last 5 years Credit Card Home Mortgage/Refinance Home Equity Loan Home Expansion Loan Appliance/Furniture Loan Student Loan Car Loan Sample Size NOTES: Income Quartile 1 includes households with income <17776 (n = 38). Income Quartile 2 includes households with income, 17776 <=inc. <35000 (n = 39). Quartile 3 includes households with income, 35000 <=inc. <50000 (n = 38). Income Quartile 4 includes households with inc. > = 50000 (n = 40). Percentages may not add up to 100 due to rounding. 18 Table 2 compares the characteristics of households based This suggests that having physical access to a formal finanon their use of selected formal and alternative financial cial institution does not necessarily preclude use of AFS services. AFS businesses include services from either curservices. Additional research is presently underway to gain rency exchanges or check cashing outlets. Column 2 disinsights into the extent to which particular AFS products or plays the characteristics of households holding a checking services are utilized by these households.4 and/or a savings account, while Column 3 reflects households with neither type of account. Households with a checking or saving account tended to have higher incomes and were more likely to be employed, more highly educated, older, male, married, and owners of a home, a car or other large assets (Column No Checking AFS Users AFS Users TABLE 2 2). Conversely, unbanked Without and No Checking or With HOUSEHOLD CHARACTERISTICS households were inclined to BY SELECTED FINANCIAL SERVICES Total Sample Checking Savings Savings Checking have lower incomes and (1) (4) (3) (2) (5) were more likely to be 194 68 41 153 N 80 unemployed, less educated, 100% 46% 21% 79% Percent of Total 54% younger, female, unmarried, and without a home, a car Gender Male 71 47% 17% 83% 53% or other large assets Female 123 45% 24% 76% 55% (Column 3). Marital Status Households that Married 71 33% 15% 84% 67% patronized AFS businesses Not Married 123 53% 24% 76% 47% Age are separated according to 18-24 9 89% 44% 55% 11% whether or not they also 25-34 29 46% 24% 76% 54% possessed a checking 35-44 50 47% 28% 72% 53% 45-59 account. As shown in 49 39% 12% 88% 61% 60-64 16 36% 13% 87% 64% Column 4 of Table 2, 46 per65 and up 41 43% 20% 80% 57% cent of the AFS-user houseEducation holds were without a checkLess than HS 15 36% 20% 80% 64% HS or equivalent 109 47% 19% 81% 53% ing account. As expected, College and Above 43 20% 9% 91% 80% the proportion of these Household Income households declines at 1st Quartile 38 82% 25% 75% 18% higher income levels, falling 2nd Quartile 39 45% 14% 86% 55% 3rd Quartile 38 44% 7% 93% 56% to 20 percent of all house4th Quartile 40 20% 11% 89% 80% holds in the highest income Employment Status quartile. Interestingly, the Employed 120 40% 16% 84% 60% majority of households Retired 44 39% 16% 84% 61% Other/Not employed 18 67% 44% 56% 33% patronizing AFS businesses Unemployed 10 80% 60% 40% 20% also have a relation with Assets the formal financial sector. Home/land/other 84 28% 7% 93% 72% Car 127 31% 10% 90% 68% Specifically, 54 percent of Credit Cards 95 67% 4% 96% 32% all households utilizing AFS services also have a checkNOTES: ing account (Column 5). The percentages reported in columns 2 and 3 are based on the total number of households in the sample, N = 194. The percentages reported on columns 4 and 5 are based on the total number of AFS user households, N = 148. 19 To better understand the use of formal and informal markets as a source of financing, we turn to information about the primary (largest dollar amount) financial sources used by households in the home purchase process. As shown in Table 3, 40 percent of all respondents are homeowners, with the majority of home-buying activity financed primarily through the formal sector (61 percent). Personal savings also represented an important primary source of funds, with 16 percent of the households purchasing their home entirely from personal savings. Only 10 percent of the homeowners used the informal market as a primary home financing source. Because the number of primary informal loans is relatively small, caution should be exercised when making direct comparisons among sources of financing. Even so, we observe that some of the loan terms differ between the formal and informal markets (e.g., lower interest rates for informal loans). In addition, households receiving a relatively large loan through informal sources also had a much lower mean income level than households financed by the formal sector. It is reasonable to believe, however, that informal financial markets are most often used as a supplement or secondary source for home financing. In fact, 23 percent of all homeowners utilized informal sources to finance some portion of their home purchase.5 TABLE 3 PRIMARY SOURCES OF HOME FINANCING n Mean Interest Mean Loan Rate Amount (nominal) (%) ($1996) Median Mean Purchase Household Price ($1996) Income ($1996) Formal Bank Mortgage Company Finance Company Government Agency Other Formal Undeclared Formal Total Formal Percent of Homeowners Informal Relatives Social Organization Undeclared Informal Total Informal Percent of Homeowners Personal Savings Percent of Homeowners No Source Reported Percent of Homeowners Total Homeowners Percent of Sample 22 13 3 3 5 1 47 61 7.3 (19) 10.4 (11) 10.7 (3) 6.7 (3) 30.5 (2) –– 9.6 (38) 82211 (21) 82613 (13) 61948 (3) 57340 (2) 8% –– 78215 (42) 102210 (19) 97006 (13) 74221 (3) 76829 (3) 116896 (5) 144928 (1) 92734 (44) 43589 (21) 67380 (10) 57500 (2) 47500 (2) 37429 (4) 76000 (1) 50622 (40) 3 2 3 8 10 12 16 10 0 (1) 4 (2) –– 2.7 (3) 72962 (2) 111532 (2) –– 92247 (4) 160861 (3) 11532 (1) 119595 (2) 50272 (6) 39500 (2) 1185 (1) 34333 (3) 30531 (6) –– –– 137818 (11) 50986 (8) –– –– 82870 (3) 49750 (8) 13 77 40 NOTES: Median year of all house purchases is 1970. Figures relate only to the single largest loan used by each household. Number in parentheses indicates reported observations used to construct means. 20 TABLE 4 HOUSEHOLD RESPONSES TO FINANCIAL SETBACK All Sources A unique feature of our survey of Financial Increase Illness or Unemployment Expenses Setback Death is its collection of information about a household's response Responses 6 8 5 3 to events that occurred over 17 16 6 17 Formal Financing 11 20 9 12 Informal Financing the previous five-year period 13 8 9 2 Use Existing Assets causing financial distress. As Increase Labor shown in Table 4, these house12 13 7 Reduce Consumption 5 hold responses include seekDelay/Fail to Pay 16 16 3 7 ing financial assistance from 29 (52%) 56 (100%) 14 (25%) 23 (41%) Total Number of Households Responding formal and informal sources, changes in labor market activiNOTES: ty and other behavioral Sum of responses is greater than total number of households responding due to multiple responses. Number in parentheses indicates percent of total households that experienced financial setbacks. There responses. The most frequently were 5 households that cited responses as “other.” cited events resulting in financial distress included substantial unemployment or periods of unusually low income, death or illness of a family member, and large increases in POLICY IMPLICATIONS AND RECOMMENDATIONS living expenses. Table 4 provides some insights into the response patterns of households facing financial distress as well as the response pattern conditioned on a specific financial setback. Overall, 29 percent of all households (56 of 194) reported having experienced at least one financial setback over the previous 5-year period. The most common reaction by households was the liquidation of existing assets (e.g., savings and checking accounts). Seeking financial assistance from informal sources and delaying or failing to pay debts also were frequently utilized responses. Conversely, formal sources were infrequently used when a financial setback occurred. While caution must be exercised regarding the policy implications that can be drawn from any one study, our research supports several recommendations. First, educational programs, conveying the benefits from having a deposit relationship and informing consumers about AFS costs, appear to be warranted. In essence, these programs will help consumers, especially lower-income households, make informed choices among financial products and services. Second, our findings confirm the need to learn more about the demand for and use of formal financial products. Community development lending opportunities as prescribed by the Community Reinvestment Act (CRA), flexible consumer loan programs, and low-cost deposit accounts could prove useful in meeting the financial service needs of lower-income and minority households. In summary, this study highlights the potentially important roles that informal markets may play as a source of financing. Continued research is needed to extend our understanding of the circumstances and characteristics inherent to a successful informal network, especially within racial/ethnic communities. 21 REFERENCES Board of Governors of the Federal Reserve System (1997). Consumer Compliance Handbook, Division of Consumer and Community Affairs. Bond, Phillip and Townsend, R. (1996). Formal and Informal Financing in a Chicago Ethnic Neighborhood. Economic Perspectives, July/August. Federal Reserve Bank of Chicago, pp. 3-27. Caskey, J.P. (1994). Fringe Banking: Check Cashing Outlets, Pawnshops, and the Poor, New York, Russell Sage Foundation. Caskey, J.P. (1997). Lower-Income Americans, Higher Cost Financial Services, University of Wisconsin-Madison, School of Business, Filene Research Institute, Center for Credit Union Research. Chicago Fact Book Consortium (1995). Local Community Fact Book: Chicago Metropolitan Area, University of Illinois at Chicago. Chicago Sun-Times (1999). Lawsuit Challenges State on Payday Loan Centers, Chicago Sun-Times, Sept. 29. Fontana, D. (1997). Need Seen to Teach the Poor about High-Tech Banking, American Banker, March 17, p. 5. Green, Mark and Leichter, Frank S. (1998). Ranking Banking: The Consumer Bank Scorecard, New York, Office of the Public Advocate for the City of New York. Hogarth, Jeanne M. and O'Donnell, Kevin H. (1997). Being Accountable: A Descriptive Study of Unbanked Households in the U.S., Proceedings of the Association for Financial Counseling and Planning Education. Huck, Paul; Rhine, Sherrie L.W.; Bond, P. and Townsend, R. (1999). A Comparison of Small Business Finance in Two Chicago Minority Communities, Economic Perspectives, Federal Reserve Bank of Chicago, May/June. Koonce, Lewis J.; Swagler, R. and Burton, J.R. (1996). Low Income Consumers’ Use of the Alternative Financial Sector, Consumer Interest Annual, vol. 42, pp. 271-274. Swagler, R.; Burton, J.R. and Koonce, L. (1995). Use of Alternative Financial Sector, Toward a Revisionist Hypothesis, Consumer Interest Annual, vol. 42, pp. 267- 270. 22 ENDNOTES 1The opinions expressed in this study are the authors' and do not necessarily represent the opinions of the Federal Reserve Bank of Chicago or the Federal Reserve System. This article is an abbreviated version of an article published in the Consumer Interests Annual, volume 45, 1999. 2As discussed by Caskey (1994), in several states including Illinois, firms that cash customers' checks for a fee are referred to as 'currency exchange' businesses. Hence, a currency exchange firm and a check cashing outlet function in virtually the same way, with the majority of revenues derived from check cashing fees. 3The Chatham project also included a random survey of small business owners. See Huck, et al. (1999). The survey instrument was adapted from a survey developed for a study of Little Village, a predominantly Hispanic community situated on the southwest side of the city of Chicago. The Little Village Survey was originally developed and funded by the Center for the Study of Urban Inequality at the University of Chicago. For a discussion of the survey instrument, see Bond and Townsend (1996) 4As pointed out by Caskey (1997), it is possible that services provided by AFS businesses are uniquely different than the services offered by a deposit institution. Also, consumers may not be fully aware of the cost differential between these two types of financial service providers. This view also is supported by Fontana (1997). Conversely, Koonce, et al. (1996) offer evidence suggesting that consumers do know that price differentials exist between AFS businesses and formal financial markets. 5Detailed information about the use of informal sources in the home financing process is available from the senior author of this article. 23 Seminar Calendar COMMUNITY DEVELOPMENT FINANCE TRAINING 2000 COMMUNITY REINVESTMENT CONFERENCE NATIONAL COMMUNITY CAPITAL 2000 CONFERENCE Dyersburg, Tennessee April 18, 2000 Palace Hotel, San Francisco, California April 17-19, 2000 Philadelphia, PA November 1-4, 2000 The workshop is for community-based organizations, development groups, state and local governments and financial institution staff with little or no experience in community development finance. Some of the topics covered during the workshop will be: • Fundamentals of community development • Investment planning that supports community development finance • Why Finance partnerships are important and how to make them work • How to increase the flow of capital and credit To register or for further information, please contact Diana Zahner at 314.444.8761. The Federal Reserve Bank of San Francisco in co-sponsorship with The Office of Thrift Supervision, The Federal Deposit Insurance Corporation, and The Office of the Comptroller of the Currency presents the 2000 Community Reinvestment Conference that will join hundreds of community investment specialists and development practitioners for an intensive three days of workshops, peer learning and best of all, fun. The 2000 Community Reinvestment Conference training focuses on the topics of Compliance, Context and Capital. From start to finish, the attendees will be engaged in a progression of exciting activities designed to enhance their CRA performance. For registration or additional information, please contact Lena Robinson at 415.974.2717 or by e-mail to lena.robinson@sf.frb.org. National Community Capital’s Annual Training Conference attracts more than 350 CDFI practitioners, investors, funders, and policy makers. The conference features training sessions specifically developed for CDFI investors and funders. For further information, please contact Adina Abramowitz, National Community Capital at 215.923.4754, ext. 205. SEIZING OPPORTUNITIES IN A CHANGING FINANCIAL LANDSCAPE COMMUNITY & ECONOMIC DEVELOPMENT CONFERENCE 2000 October 30 to November 1, 2000 The Westin Michigan Avenue Chicago, IL Topics include: • The Impact of Financial Modernization • Economic Development Strategies • Using Risk-Based Pricing • Regulatory Issues • Internet Opportunities For more information, please contact the Federal Reserve Bank of Chicago, Consumer and Community Affairs Division at 312.322.8232. 24 Profitwise is published by the Consumer & Community Affairs Division of the Federal Reserve Bank of Chicago 230 S. LaSalle St. P.O. Box 834 Chicago, IL 60690-0834 Attention: Executive Officers Board of Directors CRA Officer Community Lender Community Representative Return Service Requested CHICAGO, ILLINOIS 60690-0834 P.O. BOX 834 Consumer & Community Affairs Division PRESORTED FIRST CLASS MAIL U.S. POSTAGE PAID CHICAGO, IL PERMIT NO. 1942
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