Microfinance for Housing : Lessons from Practitioners

1. Microfinance for Housing:Lessons from Practitioners Bruce Ferguson IDB, brucef@iadb.org Microfinance of Housing: Lessons from Practitioners

2. Objectives of this presentation • Explore housing micro-finance from the perspective of housing finance and from that of microfinance • Identify policy and business-development approaches for the nexus of these two perspectives Microfinance of Housing: Lessons from Practitioners

3. What is housing microfinance? • Small loans to low and moderate-income households at short terms using various types of loan security • Typically for home improvement, although these credits also sometimes finance new construction of a small starter unit. • There are now hundreds of such housing microfinance programs and efforts in developing countries, although most are small. • Originators of these loans include financial institutions, NGOs, land developers, and building materials suppliers. Microfinance of Housing: Lessons from Practitioners

4. Housing perspective: Microfinance of Housing: Lessons from Practitioners

5. Traditional mortgage finance poorly suits the low/moderate-income majority • Mortgage loans for a complete unit are unaffordable to most low/moderate income families • Skewed income distribution • Distortions in land and housing markets raise prices • Relatively high and variable inflation and real interest rates • Long-term debt aversion of low/moderate income households • Underwriting requirements (full legal title and formal employment) conflict with reality • Mortgage finance institutions seldom have an interest in financing low/moderate income households. Microfinance of Housing: Lessons from Practitioners

6. Low/moderate income families achieve housing affordability by incremental construction • The bulk of households in most developing countries build their units incrementally over five to fifteen years. • This process starts with getting access to land – sometimes by invasion, sometimes through purchase – continues with the building a small makeshift unit, and the improvement and expansion of this unit. Microfinance of Housing: Lessons from Practitioners

7. Promise of housing microfinance • Fits the progressive housing process used by the majority of households in emerging countries. • One or more short-term loans can fund steps in this process - land acquisition, a sanitary core, or a room addition - at affordable market terms because of small loan size. • Better matches the short tenors available on domestic capital markets in developing countries • Better suits realities of low/mod households - informal incomes and para-legal tenure Microfinance of Housing: Lessons from Practitioners

8. Microfinance is the missing link in most housing programs • Most housing programs provide large subsidies for complete basic units • The latest generation - direct demand subsidy-programs seek to leverage the subsidy with a market-rate loan. As low/mod households usually lack access to credit, however, programs end up providing a larger subsidy to complete the finance of the unit. • This condemns housing programs to small scale, irrelevancy, inefficiency, and poor income targeting • The sustainable alternative applicable to most households is small loans for progressive housing, with or without subsidies Microfinance of Housing: Lessons from Practitioners

9. Key challenge: • Balance profitability with affordability. Microfinance of Housing: Lessons from Practitioners

10. Microfinance perspective: Microfinance of Housing: Lessons from Practitioners

11. The microfinance perspective:Impressive results in microfinance markets - The example of Bolivia: Microfinance of Housing: Lessons from Practitioners

12. Impressive results ... Microfinance of Housing: Lessons from Practitioners

13. Demonstration projects have succeeded. • The goal of demonstrating that microfinance can be made to work has been achieved. • Modified credit technologies make possible lending to microenterprises on an efficient and profitable basis. • Successful demonstration projects have helped to create a regulatory environment that stimulates the spread of microfinance. Microfinance of Housing: Lessons from Practitioners

14. Success has brought second-generation problems - in particular, the need for greater scale and product diversification • Success has resulted in almost saturating microenterprise markets in some countries, and low growth rates in others • Success has attracted private investors, but sound growth has proved difficult for new intermediaries • Microenterprises are more vulnerable to recession than previously thought Microfinance of Housing: Lessons from Practitioners

15. New challenges: • Enter new market segments through product diversification • Maintain or enhance credit quality Microfinance of Housing: Lessons from Practitioners

16. How attractive is the market niche of microfinance for housing? • Home loans have proved one of the safest assets of financial institutions (with one of lowest risk weights) • The unsatisfied effective demand for micro-housing loans is huge. One market study concludes that 14% of all households in three Mexican cities along the U.S. border are interested in and qualified for such a credit - a market of about $300 million • The best indicator of a household’s willingness to pay for housing improvement is the amount spent in the past. These expenditures easily add up to the amounts typical of micro loans. Some figures... Microfinance of Housing: Lessons from Practitioners

17. How attractive…Expenditures on housing improvement:(estimates based on figures from various Latin American countries) Microfinance of Housing: Lessons from Practitioners

18. How attractive…Total funds that could be mobilized by the low-income population (ideal scenario): Saving period: 3 years Credit period: 5 years Effective interest rate: 2% per month (in US$) Microfinance of Housing: Lessons from Practitioners

19. Is there already an appropriate credit supply for housing finance for low/moderate-income groups? • Financial institutions typically make purchase loans only to middle/upper income groups, and extend virtually no credits for home improvement. • Some NGO’s and cooperatives are entering the field of housing credit. Low-income land developers sometimes offer loans to finance a starter unit on the lot they sell. • Overall, great unsatisfied effective demand remains Microfinance of Housing: Lessons from Practitioners

20. What product modifications would have to be undertaken so that the (micro) credit technologies that have been developed could be applied? Microfinance of Housing: Lessons from Practitioners

21. Keys for microenterprise lenders to begin diversifying into housing microfinance • Assess demand through simple studies • Price to cover costs • Start with MFI’s current clients and a similar product: small credits for home improvement to existing clients of MFI with current underwriting methods Microfinance of Housing: Lessons from Practitioners

22. Themes for expansion • Expand: to new clients and/or to larger home improvement or new construction loans • Technical assistance for construction: develop in-house, contract, or require use of professionals designated by MFI. Include cost in pricing or have households pay directly. • Collateral: define an appropriate mix of durable goods, para-legal title, co-signers, mortgage liens etc. • Savings: establish a minimum time period and/or amount of savings for credit qualification • Funding: secure sources of longer-term liabilities Microfinance of Housing: Lessons from Practitioners

23. Keys to building the practice of housing micro-finance • Communication and cross-fertilization between the housing finance and micro-finance communities • Donor and government recognition and support • Offer credit first, and complement with a small up-front government subsidy to qualify the lowest income households • Disseminate solutions to key challenges Microfinance of Housing: Lessons from Practitioners