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Volume 1, Issue 5, 2001   Federal Reserve Bank of Dallas

Fannie Mae Foundation's Jim Carr Talks about Wealth Creation

During a recent community development conference at the Dallas Fed, Fannie Mae Foundation Senior Vice President James H. Carr talked about his research on the concentration of unregulated financial services providers in low-income and minority communities and its effect on wealth creation. e-Perspectives asked Carr a few questions about his findings, which were published with co-author Jenny Schuetz in Financial Services in Distressed Communities: Framing the Issue, Finding Solutions.

How pervasive are unregulated financial services and subprime lending?

As many as 12 million households in the United States either have no relationship with traditional financial institutions or depend on fringe lenders for financial services. These households are disproportionately poor and minority.

In lower-income and minority communities the language of finance is increasingly pawnshops, check-cashing outlets, payday lenders and rent-to-own stores. Largely unregulated in many states, the business practices of these financial services outlets differ greatly from the asset-building and wealth-creation services accessed by the majority of Americans.

According to Norman D'Amours, former chairman of the National Credit Union Administration, the number of unregulated and unlicensed financial services providers is growing nationwide, but the increase is exponential in low- and moderate-income and minority communities.

What effect does paying a subprime mortgage interest rate have on the individual borrower?

Subprime loans do not have to be predatory to seriously undermine the financial viability of households. Targeting or referring households to the subprime market in instances in which those loan applicants could reasonably have qualified for prime market loans greatly undermines the long-term asset-building potential of those households. Each additional interest point on a home mortgage totals tens of thousands of dollars on the total cost of a mortgage over the life of the loan. Subprime mortgages are routinely 3 to 4 percentage points or more higher than a comparable prime market loan. Yet a mere 1 percentage point of additional interest can make a substantial financial impact over the life of a loan (see table below).

Mortgage Payments for Different Interest Rates

30-year fixed-rate loan
House value $85,000
Down payment $4,250 (5%)
Loan amount $80,750

Annual Interest Rate Monthly Payment Annual Payment Annual Difference from 8% Lifetime Difference from 8%
8% $592.51 $7,110.18 N/A N/A
9% $649.73 $7,796.79 $686.61 $20,598.43
10% $708.64 $8,503.67 $1,393.49 $41,804.69
11% $769.00 $9,228.01 $2,117.83 $63,535.05
12% $830.60 $9,967.26 $2,857.08 $85,712.32

How do alternative financial services fees affect the asset-building capacity of lower-income households?

Even at the most modest levels, alternative financial services fees can greatly undermine the asset-building capacity of lower-income households. According to research cited by the Federal Reserve, fringe services for cash conversion and bill paying would cost an average $20,000-income household between $86 and $500 per year, while the same services at a bank would cost only $30 to $60 (assuming that low-cost banking services are available and the prospective customer is not disqualified for an account by lack of credit). Yet $500 per year saved for a period of 10 years at a modest interest rate of only 4 percent would grow to more than $6,000. That amount would be sufficient for a down payment on a modestly priced home.

Moreover, the actual costs to many households using fringe banking would be even higher if those same households also resort to payday loans, pawnshops, rent-to-own retail or auto title pawn loans. An example Robert Manning offers in his book, Credit Card Nation, is of a $196 Magnavox TV that costs $9.99 a week for 78 weeks from a rent-to-own shop, for a total of $779. Compare it with buying the same television with a credit card at 22.8 percent interest from a national discount electronics store over the same time period for a total of $231. The difference in finance charge would be $548. Assuming a household relied on fringe lenders for only an additional $300 worth of services per year, the new total of $800 of potential savings would grow to nearly $10,000 over a 10-year period, again assuming a modest 4 percent rate of return.

What do you recommend to improve the financial services environment in distressed communities?

Enhancing financial services options for lower-income and minority households and communities will require action in three areas:

  1. Improving the availability of data on financial services transactions and aggressively enforcing fair lending, equal credit opportunity and consumer protection laws and regulations.
  2. Enhancing availability of products and services designed to meet the unique needs of lower-income and lower-wealth customers.
  3. Offering consumer financial education and outreach programs.

How important is consumer education?

Even if there are improved enforcement of laws and increased products and service, it is very important to educate consumers about the types of institutions, products and services they should use and ones they should avoid. Many lower-income households have limited financial savvy and do not know the most basic aspects of household budgeting. Well-conceived, -designed, and -delivered consumer education programs can be instrumental in helping households more effectively manage their finances.

In addition, consumers need to know how to identify potentially fraudulent or otherwise questionable lenders. They need to know, for example, that when they see ads that read "No credit, no job, no problem," they should respond with "No thanks!"


For more information and the full text of Financial Services in Distressed Communities: Framing the Issue, Finding Solutions, visit www.fanniemaefoundation.org/programs/financial.pdf PDF document


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e-Perspectives, Volume 1, Issue 5, 2001

Federal Reserve Bank of Dallas Off-site page
Community Development Office Send an e-mail
P.O. Box 655906, Dallas, Texas 75265-5906
214-922-5377
Gloria Vasquez Brown Send an e-mail
Vice President
    Nancy C. Vickrey
Assistant Vice President and
Community Development Officer
Jackie Hoyer Send an e-mail
Houston Branch
Senior Community Development Advisor
    Veronica Garza
Community Development Specialist
Toby Cook
Community Development Specialist
    Diana Garza
Community Development Specialist
The views expressed are the authors' and should not be attributed to the Federal Reserve Bank of Dallas or the Federal Reserve System. Articles may be reprinted on the condition that the source is credited and a copy is provided to the Community Development Office.

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