In the mortgage crisis, smaller may be better. A story in the Washington Post indicated that smaller local banks have taken advantage of the paralysis of large institutions and thrown themselves back into local lending with a vengeance. Other studies indicate that especially with lower-income borrowers, smaller lenders did a much better job at keeping them in their homes during the financial crisis.

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The difference between lenders was startling, even with very similar pools (controlled for mortgage product, income, credit score, and debt-to-income ratios) of low-income borrowers. in this case, those who qualified for mortgage revenue bonds (MRBs). For some lenders, fewer than 9 percent of their MRB borrowers were ever 60 days late in making a payment. However, for other lenders, as many as 37 percent of their customers were similarly late in making payments.One Indiana study tracked 5,000 higher-risk home buyers and found that those who borrowed from local lenders were much less likely to be late on their mortgage or enter foreclosure than home buyers with loans from non-local lenders.

Similarly, an examination of 20,000 Ohio homeowners found that higher-risk home buyers with loans from banks with branches close to their new homes (less than ten miles) were significantly less likely to default on their mortgages.

Why would your success at home ownership depend on who's lending the money?

1. Investment in local communities Local banks may have a greater interest in supporting their communities because the domino effect of a local failure is felt quickly and keenly. One small business goes under, several folks lose jobs, less money is put back into the neighborhood, others feel the pinch, and more failure can result. The contagion could blight the town and its bank. So there may be more incentive to help right away.

2. The risk is retained When a local bank keeps your loan on its books and doesn't sell it to investors who might be hedge fund managers thousands of miles away, it has more flexibility to help its borrowers weather a hard time.

3. Different underwriting criteria. Large banks use highly-standardized underwriting, looking at credit scores and various accounting ratios to issue pass / fail grades. But local lenders often place more weight on other factors, such as how long you’ve been working for your current employer and whether you make regular deposits into a savings account.

4. Borrowers feel more obligation. The community obligation cuts both ways. Many borrowers have a relationship with their local bank, having check and savings accounts there, and may feel more pressure to make their payments. And some banks provide more education and information to riskier borrowers, equipping them to be better homeowners.

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