MEMORANDUM FROM HOUSING AND HOME FINANCE AGENCY ON REPEAL OF SECTION 2 (B) OF THE ALASKA HOUSING ACT

(Public Law 52, 81st Cong., approved April 23, 1949, as amended)

The Alaska Housing Act (Public Law 52, 81st Cong.) was designed to promote the settlement and development of Alaska by facilitating the construction of necessary housing there. Section 305 (p. 70) of S. 2938, the proposed Housing Act of 1954, would repeal the provisions of subsection (b) of section 2 of the Alaska Housing Act, as amended, thereby terminating the existing special FNMA authority to grant preferences with respect to FHA-insured mortgages covering property located in Alaska, Guam, or Hawaii, and to make direct FHAinsured loans secured by property located in Alaska.

The proposed repeal of section 2 (b) of the Alaska Housing Act will not operate to deprivé Alaska of the privilege of receiving special FNMA financial assistance since provision is made in S. 2938 for the inauguration of special assistance programs that could include programs having as their purpose the promotion of housing in the Territory of Alaska. For the reason that all of the authority for, and the limitations of, FNMA's operations have been included within the terms and provisions of S. 2938, it appeared to be desirable to repeal other acts or parts of acts which otherwise would be redundant, confusing, or inconsistent.

Attention is invited to section 301 (b) (p. 55 of S. 2938) of the National Housing Act, as it would be amended by the proposed Housing Act of 1954. That subsection states that one of the purposes of the proposed legislation is to authorize FNMA to

"provide special assistance (when, and to the extent that, the President has determined that it is in the public interest) for the financing of (1) selected types of home mortgages (pending the establishment of their marketability) originated under special housing programs designed to provide housing of acceptable standards at full economic costs for segments of the national population which are unable to obtain adequate housing under established home financing programs, and (2) home mortgages generally as a means of retarding or stopping a decline in mortgage lending and home building activities which threatens materially the stability of a high-level national economy."

Section 305 (p. 56) of the proposed new title III provides that the President, after taking factors described in the foregoing quoted language into consideramay authorize the association, for such period of time and to such extent as he shall prescribe, to exercise its powers to make commitments to purchase and to purchase such types, classes, or categories of home mortgages (including participations therein) as he shall determine. FNMA could of course, under these special assistance provisions, continue to assist in the development of Alaska housing (subject to Presidential discretion) by the issuance of advance commitments to purchase mortgages and by purchasing mortgages on an over-the-counter basis.

While section 305 contains no provisions which would permit FNMA to make direct FHA-insured loans to be secured by property located in Alaska, this omission is considered by FNMA to be of no material consequence since it is believed that the issuance of advance commitments will operate to make direct Government-insured loans largely unnecessary.

Section 302 (b) (p. 46 of S. 2938) of the proposed new title III imposes a $12,500 mortgage ceiling per living unit. The companion bill (H. R. 7839), as reported to the House of Representatives, contains the figure $15,000. On the basis of the Association's experience during the last 14 months a limitation of $15,000 would have no adverse effect on Alaska mortgage offerings. In that period, mortgages covering 1- to 4-family dwellings purchased pursuant to commitment contracts averaged $14,450 per family residence or dwelling unit; the average for each family residence or dwelling unit with respect to commitment purchases of multiunit housing mortgages was $12,465, and $14,210 with respect to 1- to 4-family dwelling mortgages purchased on an over-the-counter basis. FNMA's undisbursed commitments at December 31, 1953, for the purchase of Alaska FHA-insured section 207 multiunit rental housing mortgages show that such mortgages will average approximately $12,275 for each family residence or dwelling unit covered thereby.

The CHAIRMAN. Our next witness will be Mr. Arthur Sworn Goldman, who is a construction economist.

STATEMENT OF ARTHUR SWORN GOLDMAN, CONSTRUCTION

ECONOMIST

Mr. GOLDMAN. Mr. Chairman and members of the committee, my name is Arthur Sworn Goldman. I am a construction economist. I am grateful for the opportunity to appear today to discuss with you section 125 of S. 2938, which deals with the adoption by FHA of the open-end mortgage.

The VA, in its regulations, has recognized additional advances under an open-end mortgage guaranteed by it, if the additional advances have its prior approval.

For the past 10 years, I have been working with various building industry groups to stimulate a relatively unknown type of financing. This financing offers the same kind of encouragement to homeowners who want to maintain or modernize their properties that FHA and VA long-term insured and guaranteed mortgages offer to people who want to buy new houses.

Under this types of financing, called the open-end mortgage, a homeowner can get the money to pay for his alterations from the holder of his original mortgage, and can pay for the alterations, not over the 3-year amortization maximum provided under FHA title I, but over the remaining term of his mortgage.

There are literally millions of homeowners today who cannot afford to adequately maintain, modernize, or add to their homes, because the monthly payments on a title I loan for more than $1,000 are too steep.

As you know, $2,000 borrowed under title I would have to be paid back over a 3-year period at the rate of $63.80 a month. A typical homeowner may already be paying $57 a month on a $7,000 mortgage. Adding an additional payment of $63.80 would bring his monthly payment to over $120 a month.

This outsized payment is clearly out of the reach of the majority of the homeowners. Proof: In 1952, according to the latest Federal Reserve survey, 56 percent of all nonfarm homeowning families had incomes of less than $5,000 a year.

Thus needed property repairs and improvements are neglected or cut down, and the hard-pressed owner is obliged to settle for the cheapest materials and the most inadequate equipment available.

The new baby, quite often the third or fourth, is shoved into one or the other of two bedrooms, and we have a classic beginning of blight. Frequently the owner in the lower-income bracket makes the needed, modernization, finances it with short-term credit, overextends himself, and is forced into default. And we have another classic beginning of blight.

Two facts from the 1953 Federal Reserve Survey on Consumer Finance statistically underline the statement above:

1. In 1952, 40 percent of the nonfarm homeowners did not spend a penny for home improvement or maintenance.

2. The average expenditure of the families who did make any expenditures for repairs and modernization was only $242 in 1952.

I do not mean to imply that FHA title I has not been a useful and effective instrument. It has, and it will continue to be. The homeowner who can afford it would be well advised: (1) to pay cash or,

if not (2) to use short-term credit such as title I with a 9.7 percent interest. Title I costs the homeowner less in dollar outlay than a long-term amortized loan.

However, there is also a very read and continuing need in our economy for long-term realty credit that will enable the average American to own and keep up, without strapping himself, the most expensive purchase he is likely to make in his life.

How many of the millions of low- and middle-income families, who now own homes, could have bought them on the 3-year credit term prevalent in the twenties?

I believe we can all agree that FHA title I, together with the VA, have proved the most effective credit instruments ever devised. However, FHA, unlike VA (which permits advances), does not carry through to its logical conclusion the basic principle that has made it one of the bulwarks of a mass housing market-that there can be no mass consumption or mass production of housing without longterm credit.

FHA fails to provide adequate modernization credit for millions of low- and moderate-income families who bought FHA insured houses. It requires that architectural provision be made for a future third bedroom, but it closes its eyes to how the homeowner of modest means is to finance the third bedroom. Two-thirds of the houses put up in 1947 and 1948 had two bedrooms. Incidentally, children born last year numbered almost a million. It is easy to see why these twobedroom houses are inadequate.

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FHA is not the only institution that has not adequately provided for needed home modernization. Most of the institutions that make conventional amortized loans, with the exception of a group of gressive savings and loan associations and a sprinkling of savings banks, insurance companies, and commercial banks, are equally myopic.

So a no man's land exists in the home modernization credit field for many homeowners. And the home modernization market is in the same state, relatively, that the new house market was in prior to the advent of FHA and VA.

And yet, all these years we have had at our disposal an easy and inexpensive means of enabling the homeowner of modest means to improve his property. It is the open-end mortgage or, in more legal parlance, the mortgage that provides for optional additional advances. In legal terms, the open-end mortgage is a contract between a lender and a borrower providing that future borrowings after the original loan be secured by the original mortgage.

In less legal terms, it is a mortgage which contains a provision permitting the homeowner to borrow additional sums from his lender for the purpose of the repair, remodeling or improvement of the house covered by the mortgage.

The advances are secured by the original mortgage so that the trouble and expense of refinancing the mortgage is eliminated. The sums advanced are normally paid back over the remaining life of the mortgage, though the term of the mortgage is frequently extended instead. Usually the interest rate for the additional advance is the same as the original mortgage rate.

Many people are under the impression that the open-end mortgage permits the homeowner to reborrow only the money he has paid off on the mortgage. But this is not the case, as I shall explain later.

Let's take homeowner Smith. He was foresighted enough to insist on an open-end mortgage when he borrowed $10,000 on his 2-bedroom house. At the time his third child was expected, his mortgage was paid down to $7,000. Smith went to his lender and asked if he could reborrow $2,000 for a new bedroom and pay the advance back over the balance of the life of the mortgage.

In just about every State in the Union, except Texas, if Smith had a mortgage with a progressive savings and loan association or with Prudential or National Life Insurance of Vermont, he could get his $2,000 advance without refinancing the mortgage.

The $2,000 spread over the 10-year life remaining on this mortgage would cost him $20.74 a month. I am assuming a 42-percent interest rate. If Smith financed it through a title I loan, it would cost him $63.80 a month.

If Smith had bought his house in 1948 with a 25-year mortgage, he still could get a $2,000 advance today, even though his mortgage had not been paid down $2,000—that is, providing his mortgage secured future advances up to a total stated amount. It could have read $12,000. For example, the Kentucky statute provides that additional advances shall not exceed $2,000 in addition to the original amount loaned.

The monthly cost to Smith under these circumstances would only be $12.66, since in effect he would be paying his $2,000 back over the balance of the life of the mortgage-in this case, 20 years.

Only about 20 percent of the open-end mortgages written today make express provision for open-ending beyond the original amount of the mortgage. Yet, legally there is little reason why this provision could not be generally adopted in just about every State in the Union. It was William Levitt who first proposed this type of open-ending back in 1946. He said then:

Today we have to tell our buyer, "If you want to improve your house next year by adding another bedroom, you will have to pay for the improvement with shortterm credit at 9.6-percent interest."

If I had included the extra bedroom in the first place, FHA would have taken it into account in determining the size of the mortgage. But FHA won't take it into account if the third bedroom is added 2 days or 2 years after the transaction is completed.

It would be a very helpful thing if we could get a mortgage which would let us say to our customers, "We have arranged your financing so that when your income increases and you want to add value-increasing improvements, you can get the money quickly at low interest with 20 years to pay it back, even beyond the original total of the mortgage and even before you have created more equity by paying your mortgage down."

While it is well known that VA permits additional advances under the mortgage, it is less well known that VA stands ready any time after the closing of the original loan to guarantee supplemental loans beyond the amount of the original mortgage, to cover improvements as well as repairs and maintenance. VA's approval will be given only to the original lender and only on condition that the veteran has indicated his ability to meet the extra obligation.

Since it obviously makes sense to the Smiths of the country, you may ask why the open-end mortgage is not more widely used. Actu

ally, it is growing in use at the rate of $100 million a year. Last year one-half billion dollars' worth of this credit was advanced. Contrast this with its $34 million performance in 1943.

Here are the reasons why it is not as widely used as it could be:

1. Not enough consumers know about it. Not enough mortgage lenders know about it. And not enough dealers, realtors, builders, architects, and all the other people to whom America's homeowners turn for information know about it.

2. There is an awful lot of misinformation about its legality. Curiously enough, the laws of the land, as reflected in court decision and in the statutes, are far ahead of the thinking of most mortgage lenders. For with the possible exception of mortgages on homesteads in Texas, there is no legal doubt in the minds of many distinguished attorneys that a lender, anywhere in the United States, can re-advance funds under a properly drawn instrument and have these funds secured by the original mortgage.

With your permission, Mr. Chairman, I shall leave with you a representative list of some of the lending institutions that have been making open-end mortgages for years. You will notice that just about every State in the Union is represented. See item 1 in references, List of Lending Institutions.

The only problems arise in connection with the costs of making additional advances. If the costs of the title search in a community are reasonable, then no problem arises. If they are too costly, then lending institutions that are anxious to extend long-term credit for needed home repairs can, in the majority of States, ignore the title search because an additional advance is superior to intervening liens, without actual notice of other liens.

Frankly, I don't see why FHA needs to concern itself with the lien status, any more than VA does, because that rests entirely with the mortgage.

FHA doesn't concern itself with the variation in title costs under its title II program.

The use of the open-end mortgage provision in insured mortgages would in no way alter the responsibility of the mortgages, in the event of foreclosure, to make available to FHA a satisfactory title in exchange for debentures.

3. It takes a long time to get lending institutions to accept change. The acceptance of new concepts in the especially rigid field of real property is a particularly slow process.

But the mortgage from (and the deed of trust which is its equivalent in many States) according to Herbert Colton, former Assistant General Counsel of FHA, does from time to time respond to the evolutionary process. He points to the FHA-insured mortgage as the most striking example.

He says that public opinion following the real-estate collapse in the 1930's demanded new mortgage financing concepts to correct the glaring weaknesses inherent in short-term loans bearing a low percentage to value and supplemented by secondary loans. In response, FHA developed and pioneered a new mortgage form. Its practicality, soundness, and even the constitutionality of FHA itself was questioned by some. Legal thinking, however, quickly conformed to public opinion.

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