When a family’s income is unpredictable, managing money is hard. When income is also low, sustaining the bare necessities of life becomes a constant challenge. Recent research, including the US Financial Diaries, suggests that income volatility—weekly and monthly, as well as annually—is common. As Kathryn Edin and H. Luke Shaefer demonstrate in their book, $2 A Day, a stable job with consistent pay and benefits such as sick and family leave, which cushion the natural blows of life, is the Holy Grail of reducing debilitating volatility and increasing long-term financial health. But having a safe, affordable place to call home is essential to financial health in its own right and may be a prerequisite for getting the job that supports financial health for the long term.
The Troubling State of Housing Instability
Traditionally—and often enshrined in policy—housing “should” cost no more than 30 percent of a family’s income. Yet for lower- and even middle-income families, especially if they rent, that goal is elusive and getting more so. In 2014, 77 percent of renters with incomes between $15,000 and $29,999 spent more than 30 percent of their income on rent; 37 percent spent more than 50 percent. Almost half with incomes between $30,000 and $44,999 spent above the 30 guideline. And often owners, especially seniors with mortgages, don’t fare much better. This is economically and psychologically debilitating even when income is stable and predictable. But if income greatly fluctuates, the result can be devastating. How can we improve the situation?
The first line of defense needs to be the preservation of the limited affordable rental housing we have in the United States. Keeping affordable rental housing from being converted to market-rate housing in hot markets or from falling into disrepair in weaker markets requires action on funding and regulation. But even if we preserve all we currently have, we will fall behind. Other than the relatively few units built each year using the Low Income Housing Tax Credit, which lowers the cost of developing rental housing, most new construction is affordable only by higher-income households. Truly getting a grip on the problem of affordable rentals—especially in places with good jobs—will require more and better targeted subsidy, fewer land use restrictions, and more incentives to include affordable units in new construction.
Making Homeownership Work on a Volatile Income
Notwithstanding the devastation of foreclosures during the Great Recession, especially in lower-income communities and communities of color, homeownership remains the goal of most American families. What can we do to make homeownership more affordable in the face of income volatility?
First, we can do a better job of enabling families with volatile incomes save for homeownership—not only a down payment, but also—and at least as important—a cushion to deal with income downturns and unexpected expenses. There are a number of models for this. Perhaps the best known is the Individual Development Account, in which a nonprofit matches a family’s savings toward a goal, such as homeownership, once the family meets a target amount. Similarly, public housing authorities have the Family Self-Sufficiency (FSS) program. Families in public housing must normally pay 30 percent of income in rent, but this creates a disincentive to increase earnings; under FSS, the increase in rent that would occur with an increase in income goes into an interest-bearing account, and the family receives training and other benefits designed to enhance self-sufficiency. Upon graduation from the program, the family gets control of the account, which they can use for any purpose, including buying a home. In Germany, a savings program called Bausparen is institutionalized through the credit unions. Savings go into a pooled fund that credit unions then use to make loans. The savings earn less than standard interest rates (and saving enough to get a loan takes five to six years), but the loan is a fixed-rate loan (unusual in Europe), and the interest rate is lower than on other mortgages.
Income volatility can also impact the process of getting a mortgage. In addition to savings, lenders make mortgages based on a potential buyer’s income. Traditionally, borrowers must have two years of stable earnings, and the only income lenders take into account for underwriting is that of the borrower and co-borrower. When families have multiple earners (who may change over the course of a year—let alone the much longer term of a mortgage) whose income is variable, this can present serious difficulties. It’s much harder for the family to understand what really is affordable and for the lender to decide whether and how much to lend. Recognizing that this pattern is particularly common in immigrant families, and that such families will represent a growing portion of the potential population of homebuyers, the housing finance industry is experimenting with strategies that better reflect the structure of their income when underwriting a mortgage. For example, under Fannie Mae’s HomeReady program, income of a household member who is not a borrower can be included in determining the borrower’s debt-to-income ratio.
While income volatility can delay building up the savings necessary to purchase a home, it can have far more serious consequences after purchase. Missing payments will quickly drop credit scores, usually dramatically increasing the cost of all debt the family has. Foreclosure can set a family back for decades. Before and during the housing boom, many mortgage brokers marketed so-called “Pick-a-Payment” mortgages, in part as a “solution” to this problem. These mortgages allowed the borrower to choose from a variety of payment amounts, including some that did not even cover the interest due—thus increasing the mortgage principal (“negative amortization”). However, the mortgages proved disastrous when they reached their limit on negative amortization and payments jumped just as house prices started to fall, followed by the increase in unemployment of the Great Recession. Together, these shocks made it impossible for the borrower to make the increased payment, refinance the mortgage for a lower payment, or sell the house. Default and foreclosure became inevitable. There are better ways.
A modest idea is to better align mortgage payments with paydays for the most stable part of a family’s income. In general, this means bi-weekly payments. While some lenders have experimented with a bi-weekly payment, the structure of mortgage securities has worked against their adoption. An alternative strategy, which would require the assistance of housing counselors and other community-based organizations, is for the borrower to self-create a bi-weekly mortgage plan by putting one half of the monthly payment into a savings account each bi-weekly payday. Eventually, this will build up a cushion (equal to one monthly payment per year) that can keep the borrower current even when income fluctuates.
Another strategy would be to create a mortgage with an additional savings account—one funded by an increased monthly escrow payment—which families could use in case of emergency, based on income loss or increased expenses. The Justine Petersen Community Development Corporation in St. Louis offered this product, keeping some control over the savings account, and had significant success in building sustainable homeownership for lower-income families unable to make large down payments. Given what we know about people’s tendency to mentally compartmentalize bank accounts by purpose, even when there are no restrictions, it is possible that simply establishing such an account, and funding it through an additional payment (with an option to opt out when income is tight), would be sufficient to build up a cushion without the complexities of joint control of the account.
Finally, housing tenure choices that involve stewardship concepts—in which a third party that has a continued interest in the success of the homeowner (not just in ensuring that they make timely payments) intermediates the relationship between homeowner/borrower and lender—may provide opportunities to mitigate the impact of income volatility. These concepts, which have proven successful at small scale, include community land trusts, shared equity programs, and limited equity cooperatives.
Increasing income volatility poses important challenges to families trying to obtain and retain decent affordable housing, especially in opportunity-rich communities. But the challenge is not just for families. Unless the housing and housing finance industries can find and implement, at scale, strategies that accommodate income volatility while also providing a sufficient return on investment, they will face a dearth of future customers, especially for homeownership. We know there are strategies that work, because we’ve seen them succeed. It’s time to bring those to scale, and to keep developing additional options.