The importance of assets to well-being and economic security compels an interest by policy makers in low-income asset building (Sherraden 1991, Oliver and Shapiro 1995, Shapiro and Wolff 2001, Retsinas and Belsky 2002a). By one measure of asset poverty, as many as 41 percent of households in 1999 had inadequate savings or other liquid assets to cover three months of expenses at the poverty level (Caner and Wolff 2001).1 Even if households were to liquidate all their assets and use them to repay all their debts, one-quarter of them still would not have enough to cover three months of basic living expenses. Among those with the lowest incomes, asset poverty is more severe. Fully one-third of all homeowners and two-thirds of all renters in the bottom income quintile, for example, had $500 or less in savings and other liquid assets in 2001 (Chart 1).
Not all assets have equal appeal or priority as targets for policy. Of greatest interest are those with the potential to appreciate in value, such as real estate, or to enhance the income earning capacity of their owners, such as vehicles (under the assumption that they expand the range of locations over which employment can be found) or equity in a business. Among assets with the potential for appreciation, homes, transaction accounts and retirement accounts are the ones that are the most commonly held by low-income households (Chart 2).
Homeownership and savings are especially important to asset building. Savings provide economic security, help households avoid the steep costs of short-term credit, and are stepping stones to investments in other assets. Homes are the most commonly held asset with significant potential for large returns on small amounts of invested capital. Since homeownership is a highly leveraged investment, relatively small amounts of invested capital can earn large gains even if appreciation in the value of the underlying asset is only a few percentage points. Homeownership provides opportunities to later borrow against equity at lower tax-advantaged and secured lending rates. Furthermore, unlike other assets, housing can produce additional intangible benefits, such as access to jobs, better schools, and stronger social capital networks.2 And, relative to renting, homeownership results in enforced savings through loan amortization.
Asset building and credit are closely linked. Few households, especially those with low incomes, can acquire costly assets without credit. But even assets that do not normally require credit to acquire may nevertheless be influenced by past credit behaviors. Access to transaction accounts, for example, may be governed by past credit behavior because banks consider past history when evaluating new account applications (Barr 2001).3 In addition, the share of income that households devote to paying back short-term credit has a direct bearing on how much they have left over to save and invest.
The importance of credit to the asset building process in turns elevates the importance of the process by which credit risk is assessed and priced. This process determines the allocation and cost of credit. Because of the potential for housing to appreciate in value and the link between residential investment and the health of neighborhoods, mortgage credit has been subject to the longest standing and most thorough disclosure requirements of all credit flows into low-income communities, dating back to the Home Mortgage Disclosure Act of 1975.
This paper examines the nexus between the utilization of basic financial services, ownership of a transaction account, the creation and use of credit records, homeownership, and management of mortgage repayment risks. It begins with a model that captures this nexus and is followed by a section that elaborates on low-income homeownership as an asset building strategy. Broad patterns of asset ownership and credit use are then discussed. These patterns reveal that a large share of low-income households have no formal relationship with a banking institution (bank, thrift or credit union) and that a dual system of credit provision exists in which low-income communities are far more likely than higher income communities to be served by alternative (payday lender, check cashers, pawnshops, rent-to-own stores, and subprime lending specialists and brokers) than mainstream (banking institutions and prime lending specialists) financial service providers. These disparities are even greater among low-income minority households and communities. A review of the literature on what accounts for observed differences in asset ownership and financial service utilization by income, race and ethnicity of borrowers and communities follows. Next, the evolution of the credit risk evaluation and pricing system for consumer and mortgage credit is examined. The paper concludes with a discussion of interventions to reduce the number of unbanked and increase savings rates, improve the allocation and pricing of credit, improve consumer awareness, and expand the risk mitigation tools available to low-income households.
