Getting Out Of Poverty For Good

By Michele Learner & Todd Post

April-May 2008

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The U.S. subprime mortgage crisis has been receiving extensive media coverage lately. But many news reports miss a big part of the story: our country's poorest areas are the epicenter of the crisis and hardworking low-income borrowers are facing an ever more uncertain future.

More than three million homes are expected to go through foreclosure in 2007 and 2008. When families lose their homes to foreclosure, many will simply be forced out on the street. Most have already cut back on their living costs and exhausted their savings in an effort to prevent foreclosure. With their credit rating ruined, they may not qualify for rental housing. The result will be deeper poverty and hunger, especially in communities where poverty is already widespread. 

Today more than 12 percent of the population live below the poverty line, which was $17,170 for a family of three in 2007. Researchers have found that families need about twice the poverty level to meet the actual costs of housing, food, and other necessities. More than 90 million Americans work at low-wage jobs and live on the edge of poverty. It is low-income and minority borrowers that became the target of subprime mortgage lenders. In high-poverty counties, those with a poverty rate of 20 percent or more, subprime mortgages make up an abnormally high share of all home mortgages. According to the Center for Responsible Lending, among African American families, 52.4 percent of all mortgage loans are subprime loans, and for Hispanic families the level is about 41 percent, compared to 22 percent among White families.  

Families cannot achieve financial security simply by going to work at low-wage jobs. In fact, many people who work full time are living in poverty. Poor families, like other families, need to build up financial assets – a bank account with emergency funds, a place to live, savings for the future. Financial assets are not the only kind of assets people need. A close-knit family and good health are just two among many other valuable assets. But there is no question that financial assets are important. Such assets are resources that help people support themselves in good times and bad.

It takes time to build financial security, especially for those starting with few resources. And many low-income people who benefit from food stamps, cash assistance, subsidized child care, and other federal services are children, seniors, and people with disabilities. They will continue to need help. The opportunity to build up financial assets is a complement to essential safety-net programs – a part of what’s needed to make long-term, permanent reductions in poverty.

Life Is Unpredictable

People who are living in poverty or near-poverty are forced to plan more carefully than those with more resources. Bread for the World Institute’s 2008 Hunger Report, Working Harder for Working Families, includes the story of Renee, who spent several years living in poverty with her young daughter:

"We saved by buying food on clearance that had passed the expiration date. I cooked from scratch and never ate out; it took a lot of time but it sure saved a lot of money…. I shopped carefully, using coupons, looking for the specials in the newspaper. I made lists before going to the supermarket. If it was not on the list, I didn't buy it. I taught my daughter to do math by shopping for groceries. If it was in the basket she could add up exactly how much the bill would be before we got to the checkout line."

Despite all efforts to plan ahead, though, life without a financial cushion means that even minor setbacks may have serious, sometimes long-lasting effects. Staying home with the flu may mean losing several days' pay. If a child's asthma flares, the family may not have grocery money for the week. If someone hits the family car in a parking lot, a parent may lose her job because she can't get to work.  

In such situations, many people can turn to paid sick leave, health insurance, savings accounts, and bank loans. But low-wage jobs seldom provide sick leave or benefits such as health insurance or a matching retirement contribution. Low-income neighborhoods do not have many banks. Nationwide, 13 percent of all U.S. households, the vast majority in low-income areas, do not have a checking or savings account. Without a relationship with a bank, many doors are simply closed: free check-cashing, direct deposit, interest-bearing savings accounts, lines of credit, loans.

In short, low-wage jobs do not allow people to save up for when life takes a bad turn and poor people are both under-served and exploited by the country's financial services system. They often have to turn to unregulated companies that offer payday or Refund Anticipation Loans (RAL). These companies make loans that promise to "get you through to your next paycheck" and "help you get your tax refund faster." When people are vulnerable or desperate, they are more susceptible to exploitation and deception.

Costly "Help"

In his book Shortchanged: Life and Debt in the Fringe Economy, Howard Karger points out that to most Americans, payday lenders and check-cashing outlets are invisible, "but they are part of the landscape that makes up poor neighborhoods." In fact, the United States now has more payday lenders and check-cashing outlets than all McDonald's, Burger Kings, Targets, Sears, and Wal-Marts combined.

Payday lenders are right in the neighborhood, and they offer cash without credit checks, which take time and might disqualify some borrowers from traditional loans. But the convenience comes with a high price tag. If you take out a payday loan for $300, you receive $250 in cash and pay a $50 finance fee. You must pay back the $300 within two weeks. If you cannot, you renew the loan and pay more stiff fees. Studies of the payday lending industry find that borrowers are charged the equivalent of 450-600 percent annual interest rates. The Center for Responsible Lending estimates that payday lenders cost American families $4.2 billion every year in predatory fees. These funds could instead be used to improve families' quality of life and accumulate savings for the future.

A Refund Anticipation Loan (RAL) works along the same principles as a payday loan. It is offered by tax preparation firms so clients can "get their money right away" from the IRS. Studies of RAL borrowers show that some do not realize that they are getting a loan, i.e. money that must be paid back even if they do not receive their anticipated refund. Rather, they believe they're getting an advance on their own money.

Many RAL borrowers qualify for the Earned Income Tax Credit (EITC), which rewards work by giving low-income workers cash refunds. In fact, the EITC functions as the largest federal anti-poverty program; families who file for it receive an average of $1,900 that they can potentially put aside in savings. But the EITC also brings in money for tax preparation firms – more than $1 billion in profits each year. The National Consumer Law Center describes RALs as "usurious;" annualized interest rates run as high as 700 percent on a loan of $200.

Christian social teaching condemns "usury." The underlying principle is that lending money to financially strapped people at excessive interest rates exploits the vulnerability of people who are compelled by necessity. Locking poor people into loans they cannot repay diminishes human dignity and twists human relationships.  

Home Mortgages: Earning Less But Paying More

How did so many poor families become trapped in subprime mortgages and foreclosure? Since wages have been flat in recent years, lower-income families have seen building home equity as one of the best options for financial security. But they often cannot qualify for traditional prime-rate mortgages. Enter the subprime mortgage lender, willing to assume higher-risk loans if borrowers pay a significantly higher interest rate. In many cases, borrowers accept the disadvantages of these loans because, with a weaker credit history, it is their only chance to become homeowners. The reduction in home equity is considerable:  over the course of a 30-year mortgage on a home loan of $107,500, for example, a 13 percent subprime loan will cost the borrower $184,977 more than the same loan at a 7 percent prime rate. It takes a long time to earn that much at a low-wage job.

Taking out a subprime loan means taking a chance. Some borrowers clearly have not used good judgment. Some did not understand what could happen to their mortgage payments if interest rates rose, and some lenders took advantage of their lack of experience. Since 2004, 90 percent of the subprime loans made have included adjustable interest rates. Many subprime borrowers face an increase of 40 percent or more in their monthly payments when their initial "teaser" rates expire and are reset to higher adjustable interest rates.  

Bread for the World Institute's recent report, "Homeownership, Subprime Loans, and Poverty," shows that this type of lending is heavily concentrated in low-income communities. Nationwide, counties whose poverty rates are higher than their state's average also have higher rates of subprime mortgages. The most reliable predictor of high subprime lending is whether there's a pocket of poverty. (Read more about the report by visiting www.bread.org/institute and clicking on Asset Building).

Responding to Debt and Foreclosure in Poor Communities 

Low-income families are paying a heavier price than most as a result of the meltdown in U.S. credit markets.  In California, one of the hardest hit states, foreclosures are up by about 238 percent in 2007, and in the poorest counties, 36 percent of all mortgages are subprime, compared with the statewide average of about 15 percent.

Homeownership is one of the ways that poor people can build an asset base for the future. But subprime lenders sold risky loans to vulnerable Americans, and 30 percent of subprime borrowers now owe more on their mortgages than their homes are actually worth. Housing officials estimate that 8,000 homes are being foreclosed every day. Astoundingly, this leaves 43 percent of recent subprime loans ending in foreclosure, with an additional 40 million neighboring homeowners seeing their property value decline as a result.

As federal and state governments respond to the subprime mortgage crisis and the larger credit crisis that has shaken the U.S. economy, they need to also focus on the practices of lenders and financial services that target low-income families and communities. Families working to provide for their futures need strong consumer protections and access to transparent, well-regulated financial services.

Families also need assistance getting through this current crisis. The Center on Budget and Policy Priorities found that states experiencing economic distress, including as a result of foreclosures, had a substantial increase in enrollment in the Food Stamp Program.  Nationwide, the number of households participating in the Food Stamp Program grew 5.6 percent last year. The U.S. Department of Agriculture's preliminary data show that the number of people participating in the Food Stamp Program in Nevada, which has been at the center of the subprime mortgage crisis, jumped 15.6 percent last year. Clearly, poor people are turning to the national nutrition programs to keep from going hungry. These programs will be vital to helping families cope and eventually get out of poverty for good.