1. Is Subsidized Financing for Low Income Housing a Sustainable Option?
Olivia Caldwell
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General notes:
Add any disclaimers upfront (i.e. 40 loans is not indicative of total market)
Add sources
Add SEWA Bank process map
Add write-up of toolkit method, learnings, shortfalls

2. The Housing Value Chain
16-Sep-18

3. So what is a subsidy?
Definition: A subsidy is a government-endorsed resource of monetary value that is consciously directed to a particular customer type and point in a value chain
Can be cash or non-cash
Can be supply-side or demand-side
Can be freely available (everybody who qualifies gets one) or limited (finite number)
Goal: To expand the market by lowering opportunity costs or increasing benefits for lenders, developers or individuals
How: Cash or non cash
What is the difference between supply side and demand side subsidies?
On the supply side: Reduces the cost of purchase or rental of a home. But provides less flexibility in the choice of housing.
On the demand side: Reducing the cost of financing to purchase house. Provides greater flexibility but can drive housing prices up.
Often governments choose to implement a combination of both.
We found up to 37 subsidies in Morocco!
9/16/2018

4. Why are Housing Finance Subsidies Popular?
All governments support better housing for people
All government officials (elected or appointed) like to be seen as helping worthy households live in better housing
Real costs of the subsidies can be hidden, off-budget or deferred and are not easily quantified.
9/16/2018

5. Direct vs non-direct subsidies Cash vs non-cash subsidies
Indirect assistance
Cash
Co-payment of origination fees
Capital investment in loan origination companies
Non cash
Reduced ongoing payments
Interest subsidies
Paid direct to lenders
Loans to lenders at sovereign rate
Exemption from taxes on interest received from target customers
Credit enhancement (to allow longer tenors)
Direct assistance
Cash
Down payment/ deposit assistance
Non cash
Lower the settlement price of a home
VAT or tax waiver
Waiver of title/ recordation fees
Reduced ongoing payments
Loans directly from government
Interest subsidy
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6. What are the goals of demand side subsidies?
Increase housing finance accessibility and affordability by:
1. Decreasing interest rates
Interest buy-downs
Sovereign rate
Soft funding
But: Interest rate subsidies often have perverse consequences, pushing up prices instead of stimulating new affordable housing.
2. Increasing loan tenor
Mortgage liquidity facilities
Special funding
But: doesn’t address informal households
3. Providing credit enhancements
Down-payment assistance
Guarantees
But: credit enhancements if not designed properly can be expensive risky
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7. Example of multiple demand side subsidies
'Credit-
Market
subsidized'
loan
Amortization period (years) 15 30
Payments per amortization 12
Sovereign rate
13.0%
11.0%
Risk spread to sovereign
2.0%
1.0%
Cost/ profit spread
1.5%
Interest rate
16.50%
13.50%
Additional for DSC
1.54%
0.24%
Debt service constant (DSC)
18.04%
13.74%
DSC per payment
1.50%
1.15%
Cost of home
100,000
Loan to value
80%
90%
Down payment required
20,000
10,000
Loan amount
80,000
90,000
Monthly loan payment
1,203
1,031
Customer impact
Down payment
50%
lower down payment
Monthly payment
14%
lower payment
Loan at same monthly payment
105,025
31%
more 'borrowing power'
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8. How to reduce interest rates and monthly payments?
1. Reducing monthly payments Where do interest rates and monthly payments come from?
+ Cost of capital
+ ‘Core inflation’
+ Safe investment rate (government borrowing?)
+ Cost of origination (amortized over life)
+ Cost of servicing/ collection
+ Premium for risk/ losses
+ Bank’s overhead/ profit margin
= Minimum financeable interest rate
R = P x L
R = Risk
P = Probability of default
L = Loss if a default happens
Internal risks
Related to the individual borrower
Failure to pay the loan back
Damage to the property
Undocumented transfer
External risks
Unrelated to the individual borrower
Changes in cost of capital
Fixed and variable rate loans?
Inflation and currency depreciation
How do you lend in Zimbabwe?
‘Force majeure’
Flood, hurricane
Human action
Wars, riots
Government action
Seizure of property
Changes in law
How to reduce interest rates and monthly payments?

9. 1. Reducing interest rates Mongolia Government Loan Program
8% rate loans for 20-year terms. Program has been very successful.
However benefits households that do not need the additional subsidy. Almost 40% of program funds have been used to refinance pre-existing loans.
Distorting housing market prices . As the flats are appreciating in value faster than 8%, program subsidy causes a rise in asset value faster than the rise of cost of capital for borrowers. Pricing bubble?
The hidden-subsidy cost is high. (from June 2013-June 2014 about USD 258 million)
Invisible subsidies can be cheaper in the short run because they require no up-front costs, but much more expensive in the long run because the amount of the subsidy will increase if interest rates go up.
Beneficiaries may also begin to see (hidden) interest rate subsidies as an entitlement
Capital subsidies may replace the economic consequences with less market distortion.
9/16/2018

10. Oversolving the problem in Jamaica?
Low-interest 30 year mortgages available for all to buy ‘starter homes’ in Jamaica
But who is buying the homes? Do the homes get resold? Who gets the benefit then?
High costs to government and need for targeted programs in order to improve subsidy efficiency
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11. 2.Extending loan tenor Government supported Mortgage Liquidity Facilities
Extend loan tenor by providing banks with access to long term funds and mitigating maturity mismatches
Popular implementations in Malaysia, Mexico, Egypt, Tanzania and Nigeria where banks could not raise funds directly from capital markets
First start with capital injection by the government or multilateral, and later seek to achieve sustainability by building secondary mortgage markets
But some preconditions need to be in place for MLFs to reach sustainability including the existence of a regional bond market.
Sustainability of developed MLFs can be affected by macro events: Fannie Mae
Governments provide subsidized funding directly to state-owned housing banks (0% long term housing loans in Saudi Arabia and Kuwait).
Costs and distortions imbedded in such special non-market funding systems often have side effects
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12. 3. Credit enhancements Down payment assistance US
Charities providing 3% down payment on Federal Housing Administration (FHA) insured housing loans (average of 3400$)
In 2007 they were banned due to high rates of foreclosure
More than 100,000 low- and moderate-income consumers bought homes per year. Equivalent to 34% of FHA loans
Double foreclosure rate.
June 10, 2008 FHA expected to lose $4.6 billion because of unexpectedly high default rates
Down payment was being paid for by developers who increased price of homes
“Equity is the evidence of a demonstrated capacity for saving. It also secures the borrower’s undivided attention.”
Hard equity demonstrates a capacity for saving, and creates a psychological investment. A no-money-down purchase achieves neither objective.
Non sustainable program
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13. 3. Enhancements Case study: FOGARIM Morocco
Until interest-rate subsidies of 3.5% for low-income and 2% above with VAT exemption (incomes under 360$/month) .
But excluded clients with unsteady incomes.
It cost on average US$30 million a year for about 10, 000 beneficiaries
FOGARIM launched in 2003 as a Guarantee Fund to promote housing finance down-market
Covers 70% of principal balance after 9 months of default
Success: rates fell from 7% to 5% and terms extended from 7 to 25 years
September 2014, 12,332 slum dwellers had benefited from FOGARIM-guaranteed loans.
But sustainability issues due to high levels of default?
9/16/2018

14. Conclusion Are subsidies sustainable?
Economically sustainable only if they have an associated ‘evergreen’ revenue stream
Public-policy sustainable only if they are seen as fair and efficient
Fair = Target worthy households
Net present cost of subsidy= value to the household
Administratively sustainable only if they operate in reality as originally envisioned
Risks do not mushroom out of control
Impact in the market is positive, not distorting
Hidden cost and market-distorting impacts of financial-sector subsidies makes more and more countries reform their systems for more transparent subsidies
Politically sustainable only if they maintain political support
Visible vs hidden subsidies
Beneficiaries distributed across the political spectrum
Urban and rural
Poor and middle class
9/16/2018

15. Is subsidized financing for Low Income Housing a sustainable option?
Olivia Caldwell
Picture
General notes:
Add any disclaimers upfront (i.e. 40 loans is not indicative of total market)
Add sources
Add SEWA Bank process map
Add write-up of toolkit method, learnings, shortfalls