In Massachusetts, the SoftSecond Loan Program serves lower-income first-time homebuyers such as Noemy Martinez, who bought this two-family home in Lynn, a city 12 miles north of Boston. (Photo courtesy of Massachusetts Housing Partnership)

Long before phrases like “qualified residential mortgage” or “credit risk retention” were bandied about in Washington, community activists in Boston, incensed by a 1989 study that found a pattern of racial bias in Boston’s mortgage lending, demanded action.

What they got was the SoftSecond¨ Loan Program, which, over its 20-year history, has financed over 15,800 home purchases by low- and moderate-income families, representing $2.5 billion in bank mortgage financing. With significant lender-retained risk and loan performance that compares favorably to prime mortgage benchmarks, SoftSecond provides strong empirical guidance that can be useful in shaping a new national policy on extending credit to support responsible homeownership, something our economy desperately needs.

Community Pressure Yields Innovative Mortgage Product

The 1989 study by the Federal Reserve Bank of Boston was front-page news in The Boston Globe for nearly a year. It caused a torrent of criticism since the banking industry’s failure to serve minority homebuyers could not be explained by income, credit history, or other legitimate loan underwriting factors. Political leaders and community activists demanded that banks make more investments in non-white and lower-income neighborhoods, while the banks resisted, concerned that loans to lower-income homebuyers would result in massive defaults and foreclosures.

Representatives from the Massachusetts Housing Partnership (MHP), the Massachusetts Affordable Housing Alliance (MAHA), the Massachusetts Bankers Association, Boston city officials, and others began meeting to find common ground and potential solutions. This working group designed a mortgage product with new underwriting standards for inner-city properties that would address common obstacles facing lower-income, first-time homebuyers, like high downpayments and costly private mortgage insurance.

The result was SoftSecond, a collaborative program between the banking industry and state government. Participating homebuyers receive two fixed-rate bank mortgage loans: a first mortgage loan for 77 percent of the purchase price and a second mortgage loan for 20 percent. Both loans are offered with favorable pricing and no points charged, sometimes at a discount. The program requires a 3 percent downpayment (originally 5 percent), at least half of which must come from the homebuyer’s own funds (the balance can be a gift or through a down payment assistance program).

The second mortgage loan is “soft” for the first 10 years, that is, payments are interest-only and are further reduced by state subsidies for income-qualified homebuyers. The state funds loss reserves for each bank (currently 3 percent of the second loan), so borrowers don’t need private mortgage insurance. This unique blend of fixed-rate private financing and state support lowers a borrower’s monthly mortgage payments by about 20 percent.

SoftSecond homeowners may sell their properties at market value. Any interest subsidy funds provided to the homeowner are required to be repaid upon sale; after five years of ownership, borrowers retain at least 80 percent of any net appreciation.

Launched as a pilot program in Boston in 1991 and expanded statewide in 1992, the program has served 4,858 first-time buyers in Boston and 11,028 first-time buyers in the rest of the state. In Boston, 68 percent of Boston SoftSecond homebuyers identified as non-white and/or Hispanic/Latino; 48 percent did statewide. Although buyers with incomes up to 100 percent of the area median income are eligible, 57 percent of SoftSecond buyers have incomes at or below 60 percent of area median income (average household income for SoftSecond buyers of $52,162 compared to median income in the Boston area, currently $96,500). In the past year 45 percent of SoftSecond purchases were in Massachusetts cities hardest hit by foreclosure. By placing a focus on low-income areas, the program can responsibly serve the lowest-income buyers and promote sustainable homeownership.

SoftSecond loans have performed extremely well. Delinquency rates have consistently been comparable with those of prime mortgage loans in Massachusetts and foreclosure rates have been consistently lower. As of September 30, 2011, the delinquency rate for prime loans in Massachusetts was 5.60 percent; SoftSecond was 5.96 percent. The foreclosure rate for prime loans in Massachusetts was 1.88 percent; SoftSecond was .86 percent. As of September 30, 2011, the FHA delinquency rate for Massachusetts loans was 10.43 percent.