'Declining Markets' and Self-Fulfilling Prophecies

Could designations of Zip codes, metropolitan areas and entire states as "declining markets" hinder a real estate recovery and hurt minority groups and moderate-income buyers disproportionately? Growing ranks of critics say yes.

Since late 2007, most lenders, insurers and mortgage investment firms have compiled lists of markets that they regard as higher risks because housing values are dropping. In those areas, borrowers are charged higher rates and loan fees and are required to make bigger down payments -- costs that can rise significantly when applicants have credit scores below designated minimum levels.

In some cases, the extra fees can add more than two percentage points to the interest rate and require much more cash up front. At their extreme, declining-market designations remove entire categories of real estate from financing eligibility. Some private mortgage insurers, for instance, won't touch second homes or rental-home investments anywhere in large swaths of Florida and California.

Industry estimates on affected Zip codes range from 8,000 to more than 12,000 across the country. Many parts of the Washington area are included.

But now a broad reaction against such policies is taking shape. Some groups are demanding that lenders and investors abandon or modify their approaches and are urging mortgage insurers to loosen up on theirs.

An alliance of three real estate trade groups representing Hispanics, blacks and Asian Americans recently asked the mortgage industry to get rid of its patchwork of proprietary -- and often contradictory -- lists and replace them with a single, more flexible and transparent policy for assessing the "true risk" on real estate in local markets.

Timothy Sandos, president and chief executive of the National Association of Hispanic Real Estate Professionals, said current policies have the effect of cutting out or penalizing huge geographic areas that contain many smaller sub-markets where values are relatively stable or do not pose exceptional risks. Sandos wants greater emphasis on what appraisers find and document about the direction of local markets, rather than computer-generated statistical models.

This "would allow homes to be evaluated as individual risks," Sandos said, rather than painted wholesale as "declining" when they are not. Minorities and moderate-income households may be disproportionately affected by such broad-brush designations, he added, and they are often less able to come up with the higher down payments and extra fees demanded. That makes selling and buying tougher in their neighborhoods, lowers demand and prices, constituting what Sandos calls "a circular, self-fulfilling prophecy," with the designation fueling further decline.

Sandos' group wrote the critique with the National Association of Real Estate Brokers, which represents black real estate professionals, and the Asian Real Estate Association of America.

The biggest real estate lobby, the 1.3-million-member National Association of Realtors, also has weighed in on the issue. In April 11 letters to the chief executives of Fannie Mae and Freddie Mac, Richard F. Gaylord, the group's president, asked the two companies to "discontinue the policy of stigmatizing entire Zip codes" and metropolitan areas as declining markets because they "typically include widely differing" neighborhood conditions.

Although Fannie Mae's and Freddie Mac's policies permit lenders to make exceptions to declining-market designations, Gaylord said "the reports we hear are that [lenders] are extremely reluctant to do so" -- for fear that they'll be forced to buy back loans if borrowers default.

Steven Brooks, executive vice president of Flagstar Bank, a lender based in Troy, Mich., confirmed that, as a general rule, if Fannie Mae's automated underwriting system identifies an area as declining, "we typically will follow that" in underwriting and pricing a loan application.

However, he said, "on a case by case basis" -- when an appraisal comes in with a strong, well-documented valuation -- "we do make exceptions" and override Fannie's automated advisory.

Spokesman Brian Faith said Fannie Mae has "sought and received input" from consumer and industry groups on the issue, "and we take it seriously." Faith said Fannie is "considering making changes and refinements" in its policies but has no specific details. Freddie Mac spokesman Brad German said "we are always reevaluating" policies, including this one.

For the time being, if you own a property or plan to buy in any of dozens of metropolitan areas and thousands of Zip codes dubbed declining, expect to pay extra when you apply for a loan: at least 5 percent extra on down payments, a higher interest rate and maybe a more limited menu of loan options.

That's the case even if the property is gaining in market value and sales in your neighborhood are on the upswing.

Kenneth R. Harney's e-mail address isKenHarney@earthlink.net.