What is a Location Efficient Mortgage and How Does It Work

A location efficient mortgage is a type of mortgage that takes into account the costs associated with a particular location, such as transportation costs and housing costs.

These costs can be significant, with some locations requiring long commutes to work or school, or having high housing costs.

A location efficient mortgage is designed to help borrowers make more informed decisions about where to live and how much house they can afford.

By considering the costs of a location, borrowers can get a more accurate picture of their overall housing costs and make a more informed decision about their mortgage.

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The Location Efficient Mortgage (LEM) was a game-changer in the world of mortgage financing. It was developed in 1995 by the Institute for Location Efficiency (ILE) and allowed homebuyers to increase their borrowing capacity based on the premise that they would spend less on transportation, and therefore have more disposable income, than the national average.

The LEM was a joint effort between CNT, the Natural Resources Defense Council, and the Surface Transportation Policy Partnership. Fannie Mae, the nation's largest source of home mortgage funds, sponsored a market test of the LEM in 2003, investing at least $100 million in LEMs.

A household earning $50,000 a year could qualify for a $163,000 mortgage under standard lending practices, but with a LEM, they could qualify for a $213,000 loan if they lived in a compact, transit-accessible and pedestrian-friendly neighborhood.

The LEM was discontinued in 2008, but its impact on the mortgage industry was significant. It paved the way for competing products, such as Fannie Mae's SmartCommute, which gave borrowers extra credit for living near public transportation.

Research has shown that location-efficient homes perform better in the market, holding their value better than other homes. This means that borrowers who own location-efficient homes are more likely to avoid foreclosure through alternative measures, such as selling or refinancing the home.

Studies have found that default probability increases with the number of vehicles owned after controlling for income, but decreases with higher Walk Scores in high-income areas. The impact of location efficiency on default is nontrivial, suggesting that researchers and policymakers should prioritize location efficiency when developing mortgage underwriting models and land use policies.

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The Housing to Income Ratio is a key factor in traditional mortgages, limiting the amount of money available to 35% of the household's income. This ensures that after the mortgage is granted, the household can still afford other obligations.

In high-density, transit-rich environments, the reduced cost of transportation can significantly increase the amount of money available for a mortgage. For example, in Chicago, Illinois, this savings can be as much as $350-$650 per month.

The Housing to Income Ratio can be as high as 39% in these environments, allowing urban dwellers who depend less on automobile use to purchase a more expensive home. This is a result of factoring in the extra savings from reduced transportation costs.

These Location Efficient Mortgages (LEMs) are resalable on the secondary market through the Federal National Mortgage Association (FNMA).

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Location efficiency is a key factor in mortgage performance, and it's not just about saving money on gas. The number of vehicles owned per household, scaled by income, is a significant predictor of mortgage default.

Research has shown that default probability increases with the number of vehicles owned, even after controlling for income. This is because households with more vehicles often have higher expenses, making it harder to make mortgage payments.

Walk Score, a measure of how walkable an area is, also plays a role in location efficiency. In high-income areas, default probability decreases with higher Walk Scores, suggesting that residents of these areas benefit from being able to walk or bike for daily needs.

However, in low-income areas, higher Walk Scores are associated with increased default probability. This may be because residents of these areas rely more heavily on vehicles for transportation and may not have the same access to alternative modes of transportation.

These findings suggest that location efficiency is a complex issue, influenced by a range of factors including income, transportation options, and neighborhood design.

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Location efficient mortgages can provide numerous benefits for consumers, developers, and urban neighborhoods. Consumers benefit from improved housing and transportation options, making housing more affordable and reducing transportation and parking costs.

Developers can take advantage of more design flexibility, including opportunities for infill development and reduced parking costs. Location efficient mortgages create new markets and financing options, increasing the amount households can spend on housing.

Urban neighborhoods can benefit from increased opportunities for middle-class infill development, reduced motor vehicle traffic, and improved community livability. Location efficient development tends to increase community livability and reduce regional traffic congestion.

Mortgage default rates are lower in location-efficient neighborhoods, indicating that households are better equipped to handle unexpected financial burdens. Location efficient development can reduce regional traffic congestion, road and parking facility costs, traffic crashes, pollution, and sprawl.

Location efficient development can also provide substantial energy savings and pollution emission reductions. According to one study, Location Efficient Development could reduce total U.S. energy consumption by about 10% after a decade.

Here are the benefits of location efficient mortgages:

Location Efficient Mortgages are implemented by residential mortgage lenders, often with the support and encouragement of government agencies such as Fannie Mae and the Canadian Mortgage and Housing Corporation.

Lenders use a model to determine which locations have lower transportation costs, and therefore can qualify for higher mortgage payments. This model considers factors like proximity to high-quality transit service, public services within walking distance, carshare services, and parking management.

The Location Efficient Mortgage was a joint endeavor that began in 1995, starting with a three-year research program led by CNT, the Natural Resources Defense Council, and the Surface Transportation Policy Partnership.

Location Efficient Development is implemented by developers with support from local governments, often as part of Smart Growth and New Urbanist planning. This approach can be a catalyst for Transit Oriented Development.

Location Efficient Mortgages are implemented by residential mortgage lenders with the support of government agencies like Fannie Mae and the Canadian Mortgage and Housing Corporation. Lenders use a model to determine which locations have lower transportation costs.

Proximity to high-quality transit service is a key factor in these models, such as a rail transit station or a bus line with frequent service. This can qualify locations for higher mortgage payments.

Number of public services within convenient walking distance is also considered, including schools, shops, parks, medical services, and pharmacies. Carshare services within walking distance are another factor.

Parking management is also important, such as unbundled parking that doesn't force residents without cars to pay for parking.

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Fannie Mae sponsored a market test of the Location Efficient Mortgage (LEM) in 2003, investing at least $100 million in LEMs in four metropolitan market areas: Chicago, Seattle, Los Angeles, and San Francisco.

The LEM allowed potential buyers of households in urban neighborhoods to increase borrowing capacity based on the premise that they would spend less on transportation, and therefore have more disposable income, than the national average.

Fannie Mae defined the guidelines of the LEM mortgage product and authorized lenders to issue LEMs in the four metropolitan market areas.

The LEM increased the standard loan underwriting limit from 28% to up to 39% by factoring in transportation-related cost savings.

For example, a household earning $50,000 a year could qualify for a $163,000 mortgage under standard lending practices, but could qualify for a $213,000 loan if they lived in a compact, transit-accessible and pedestrian-friendly neighborhood.

Fannie Mae also introduced SmartCommute in 2002, which gave borrowers extra credit to household budgets for living near public transportation, allowing them a slight edge in qualifying for loans.

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The LEM was discontinued in 2008, but its impact can still be seen in the development of affordable housing near transit stations and the promotion of location-efficient communities.

Here are some key features of the LEM:

In many metropolitan areas, working families with moderate incomes are shouldering a significant burden when it comes to housing and transportation costs. On average, these families spend nearly 30% of their income on transportation, which is almost as much as they spend on housing.

The combined burden of housing and transportation costs is remarkably similar across different metropolitan areas, ranging from 54% in Pittsburgh to 63% in San Francisco. In fact, 25 out of 28 metropolitan areas have a combined burden within three percentage points of the average.

This high burden is not limited to working families; among all American households, housing and transportation are the two largest expenses, consuming a total of 48% of income.

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Portland's housing policy has a significant impact on the income mix of its residents. The city's location-efficient housing and mortgages tend to increase equity by allowing households that own fewer than average automobiles to avoid paying for parking they don't use.

This is particularly beneficial for lower-income households and non-drivers, who are often excluded from suburban, middle-class car ownership rates. Residential parking requirements reflect these excessive rates, which is both unfair and regressive.

Location Efficient Development is optional, so consumers will only choose it if they consider themselves better off overall. This means that households that can afford it will opt for location-efficient housing, leaving behind those who cannot.

Here are some key benefits of Portland's housing policy:

By prioritizing location-efficient housing, Portland's policy promotes fairness and equity among its residents, particularly those with lower incomes.

Across the United States, housing and transportation costs are the two largest expenses for many families. In 17 out of 28 Metropolitan areas studied, working families with annual incomes between $20,000 and $50,000 spend more on transportation than on housing.

Transportation costs can be staggering, taking up nearly 30% of a working family's income, with an average of $10,400 spent per year. This includes expenses like commuting, traveling for school, and daily errands.

In some cities, like San Francisco, transportation costs can be even higher, making up as much as 63% of a family's income. On the other hand, in cities like Pittsburgh, the combined burden of housing and transportation costs is relatively lower, at 54%.

The combined burden of housing and transportation costs is a significant issue, with 25 out of 28 Metropolitan areas studied having costs that are within three percentage points of the average combined burden of 57%.

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Location efficient mortgages can be a game-changer for those who want to buy a home in a desirable area without breaking the bank.

One major barrier is the high cost of housing in popular locations, which can lead to a significant portion of income being spent on mortgage payments, property taxes, and insurance.

However, with location efficient mortgages, borrowers can save up to 20% on their mortgage payments compared to traditional mortgages.

This is because location efficient mortgages take into account the borrower's income, credit score, and other factors to determine a more affordable mortgage payment.

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Implementing Location Efficient Development and Mortgages isn't easy, and it requires overcoming various types of resistance in mortgage, real estate, and local planning institutions.

Pilot projects can be helpful in propagating these concepts, allowing for hands-on learning and experimentation.

Case studies can also provide valuable insights and lessons learned from previous implementations.

Professional education workshops may be necessary to educate stakeholders and build a shared understanding of the benefits and challenges of Location Efficient Development and Mortgages.

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Research has shown that location-efficient homes have lower foreclosure rates. A study of over 40,000 mortgages in Chicago, Jacksonville, and San Francisco found that default probability increases with the number of vehicles owned after controlling for income.

The study used two proxy variables for location efficiency: vehicles per household scaled by income and Walk Score. Higher Walk Scores in high-income areas were associated with lower default probabilities, while higher Walk Scores in low-income areas were associated with higher default probabilities.

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This suggests that location-efficient homes might hold their value better than other homes, enabling borrowers to avoid foreclosure through alternative measures, such as selling or refinancing the home. The study's results also support the notion that government policies around land use, zoning, infrastructure, and transportation could have significant impacts on mortgage default rates.

The study's findings have implications for mortgage underwriting models and government policies. Researchers should test the impact of location efficiency variables within their models, and some degree of greater mortgage underwriting flexibility could be provided to assist households with the purchase of location-efficient homes.

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