Small Mortgages Are Getting Harder to Come By

Some low- and middle-income home buyers are having a hard time getting mortgages for an unexpected reason: The loans they’re applying for are too small.

Lenders extended about 106,000 mortgages with balances between $10,000 and $70,000 in the U.S. last year, worth $5.1 billion. That is down 38% from almost 171,000 in 2009, according to figures compiled by Attom Data Solutions, a real-estate data firm. The drop-off at the bottom end of the market has been far swifter than at the top. Origination was down a more modest 26% for mortgages between $70,000 and $150,000, and it rose 65% for mortgages above that range.

Only about a quarter of homes that sold for less than $70,000 were financed with a mortgage, while almost 80% of sales between $70,000 and $150,000 had one, according to an Urban Institute analysis last year. Low-end borrowers had their applications denied at a higher rate than those taking out bigger mortgages even when comparing borrowers with similar credit quality, according to the think tank.

Housing experts say small mortgages have become rarer because lenders have trouble making profits on smaller loans. Lenders typically have a fixed cost to extend a mortgage, and the smaller the loan, the smaller the profits.

“The whole system incentivizes high[-balance] loans,” said Michael Bright, the president of the Structured Finance Industry Group.

Instead, many lenders are catering to more high-end borrowers. Jumbo loans—those too large to sell to government-sponsored guarantors Fannie Mae and Freddie Mac —have been a bright spot for banks. Financial institutions have grown increasingly competitive when trying to attract these customers, in part because they are seen as prime targets for selling additional services.

The dearth of smaller mortgages is becoming an impediment to home buying in regions where prices are otherwise affordable, especially in Midwestern and Southern cities like Chicago, St. Louis, Youngstown, Ohio, and El Paso, Texas, according to local housing advocates and attorneys.

For many home buyers, the difficulty of obtaining small mortgages represents another rung sawed off the ladder to upward mobility.

“Like everything else in our economy, the housing market has become less equitable,” said Julia Gordon, president of the National Community Stabilization Trust, a nonprofit whose work focuses on neighborhoods with low-price homes.

Bertha Elwood went shopping for an $11,000 mortgage in the last few months for her home in Witt, Ill., but two lenders told her the amount she was looking to borrow was too small. One said she had to borrow at least $50,000 and another told her to borrow at least $75,000, according to Ms. Elwood.

“I don’t owe that, and I don’t want to pay that,” she said.

Ms. Elwood needed a mortgage to get out of a contract for deed—a hybrid between renting and buying where the borrower makes a down payment and monthly installments, typically to the seller, but doesn’t get the title or rights of homeownership until the end of the term.

She entered into her contract in 2014 with a relative, who ran into payment difficulties that resulted in his bank beginning foreclosure proceedings last year. Without her own mortgage to buy the property outright, Ms. Elwood believes she may lose the house, despite having paid roughly $30,000 over the last five years.

Chelsea Hubbard, an attorney at Land of Lincoln Legal Aid in Alton, Ill., said she has seen many buyers end up in contracts for deed because other financing options aren’t available. In these contracts, home buyers typically have little recourse if they fall behind on payments before having paid the purchase price in full.

“It just kind of spirals downward if they don’t have access to credit,” she said.

Real-estate agents and buyers say lenders are less willing to help small-loan seekers overcome obstacles such as credit blemishes that tend to complicate applications for traditional loans, and which may be less problematic for buyers of comparable means seeking bigger mortgages.

Two of Ms. Hubbard’s clients, Sarah and Joshua Fuller, entered into a contract for deed on their Granite City, Ill., property in 2015 after they were told that a recent bankruptcy made a traditional mortgage unattainable. By last year, they had improved their finances and wanted to take out a mortgage to replace the contract. The couple approached five banks about a $20,000 mortgage.

They ran into a problem that isn’t unusual with small-dollar mortgages: an appraisal gap. Their property appraised at $27,000, below the $39,000 purchase price. As a result, every lender turned them down.

“A couple of them even said we were better off cutting our losses because no bank would lend to us,” Mrs. Fuller said.

Some properties that are sold below $70,000 need updating or are in neighborhoods without enough comparable homes. Because of that, homes can end up appraising at a lower value than their sale price, which scuttles the deal if the buyer can’t pony up more cash to cover the difference.

Without a loan, the Fullers ended up reluctantly extending their contract for deed. After a series of hardships, they fell behind on their payments and were served with an eviction notice and a lawsuit. Ms. Hubbard was able to get them out of the contract, but with nothing to show for the money they had already put in. They moved in with Mrs. Fuller’s parents on Christmas Eve.

Sherry Pinkston, who lives in Chicago between the Morgan Park and Beverly neighborhoods, was looking to buy a condo in her building for her daughter a few months ago. But she was denied approval for a $40,000 mortgage.

Ms. Pinkston said the reason she was given for the denial was her credit score, which is in the mid-600s. That is slightly below the average for the Federal Housing Administration-backed loan she was looking for, but not disqualifying. She said she has an annual income of around $72,000.

“I see people making less money than me getting $200,000 loans,” she said.

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