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The quest to raise homeownership rates. (Cover Report: Industry Trends).

Article Excerpt
Studies of the most effective ways to raise homeownership rates suggest direct cash assistance gets the most bang for the buck. The simulations of home-buying behavior show cash assistance outstrips the effectiveness of the lower mortgage rates brought about by conforming loans.

A POLICY PRIORITY IN THE UNITED STATES IS to increase the rate of homeownership. To achieve that objective, policy-makers rely on a host of policies and programs that reallocate billions of dollars of resources. Several of these policies and programs try to increase homeownership by reducing mortgage rates. More specifically, federal sponsorship for Fannie Mae and Freddie Mac is one of the major tools that policymakers rely on to reduce mortgage rates.

Given the public resources involved, it seems reasonable for the general public, mortgage and housing professionals, and policymakers to consider the degree to which the mortgage rate reduction produced by Fannie Mae and Freddie Mac increases homeownership. Most of the evidence reviewed in this article finds that mortgage rate changes need to be around 2 percentage points before they have what many would consider a modest but not trivial effect on homeownership. Because Fannie Mae and Freddie Mac reduce mortgage rates on the order of 20 to 50 basis points, the effect of their rate reduction on homeownership is likely to be quite modest although, again, not trivial.

Moreover, the evidence presented here also suggests that a more direct method of subsidizing potential homeowners would have a larger effect on homeownership (while using the same amount of resources) than the reductions in mortgage rates attributed to Fannie Mae and Freddie Mac.

Several caveats are in order when considering these conclusions. Analysis of homeownership and mortgage rates is complicated by a number of factors, including the complexity of the decision to own and data concerns. As a result, the studies summarized all have important weaknesses. In addition, Fannie Mae and Freddie Mac could increase homeownership through means other than lowering rates, such as encouraging reductions in down payments.

Moreover, the two firms have several explicit legislative objectives, and "increasing homeownership" is not one of them. Even with these limitations, the evidence discussed here appears relevant for the existing, vigorous public discussion centered on mortgage rates, homeownership and Fannie and Freddie's activities.

Mortgage rates and homeownership

The 2002 annual report of the Federal Reserve Bank of Minneapolis features a discussion of how changes in mortgage rates affect homeownership (available online at www. minneapolisfed.org). I have summarized the material from that discussion in this article, focusing on simulation evidence. Specifically, analysts use two types of simulations to examine how changes in mortgage rates affect homeownership. In the first type, they simulate the loan underwriting process to determine how mortgage rates affect the ability of households to qualify for a mortgage....