The traditional American starter home—the quaint, ranch-style two-to-three bedroom home young families once began their journey of wealth creation—is on life support. The U.S. is currently short nearly 4 million homes, according to Goldman Sachs. A number of factors have defeated that essential stepping stone, from sky-high prices to strangling zoning constraints. But for Better.com CEO Vishal Garg, the main barrier lies in the mortgage.
“One of the core reasons why people, even the home builders, don’t build starter homes in America is nobody’s willing to give mortgages for starter homes,” he told Fortune.
His logic: the traditional mortgage industry relies on human loan officers who are typically paid a commission of 1% to 2% of the total mortgage amount. One percent is a much bigger payoff on a loan for a $1 million house than for a $100,000 unit. Because of this structure, loan officers prioritize the largest loans possible to maximize their pay.
“American consumers who have a mortgage amount less than $300,000, they don’t get treated well at all,” Garg said.
The shortage of starter homes is in part why the median first-time homebuyer age hit a record high of 40 last year, and why first-time buyers now comprise a record-low share of just one-fifth of all buyers, according to the National Association of Realtors.
Starter homes tend to be smaller, and therefore cheaper. A typical starter home is usually under 1,400 square feet. The median size of homes built today has actually shrunk from a peak of 2,466 square feet in 2015. One might expect that trend to be good news for first-time buyers. But “shrinkflation” has hit the housing market, and smaller builds today are getting more and more expensive. New builds cost 74% more and are 11% smaller than they were a decade ago, according to Lendingtree.
For many young people, homebuying now seems an intangible fantasy reserved for middle age. Some are relying on the “Bank of Mom and Dad” to get a foot in the door. Others are merely waiting on the sidelines, hoping for mortgage rates to fall below 6%, cheaper housing, and more housing stock .
Can AI solve the housing affordability crisis?
Garg is betting on AI to fill the mortgage gap. By replacing much of the work humans do, the CEO claimed Better.com’s AI tool, Betsy, cuts the cost to process a loan from the industry average of nearly $12,000, according to Freddie Mac, to $3,000. Garg said that $9,000 reduction makes it financially viable to service the smaller starter-home mortgages human loan officers typically avoid. “The AI enables everything to get a lot cheaper to actually be able to service those [starter homes],” he said.
Garg believes AI can provide younger and often underserved buyers with customized instruction typically reserved for elite private bank clients. Unlike human loan officers who may lack the tools or incentive to provide granular financial advice for smaller loans, the AI functions as a search engine that offers actionable research.
Poor credit history accounts for nearly half of loan denials for purchase mortgages under $100,000, according to the Department of Housing and Urban Development. The platform can instruct a borrower to pay off a specific credit card or reduce a monthly car payment to reach a higher credit tier. That can help them qualify for a lower interest rate. This type of automation, Garg said, essentially democratizes financial coaching, affording everyday borrowers the same advice otherwise reserved for the ultra-wealthy.
When asked if AI will solve the housing affordability crisis, Garg answered an enthusiastic “totally.”
Why starter homes are disappearing
Even as new homes shrink, their higher price tags mean they’re generating bigger mortgages, not the sub-$100,000 loans that first-time homebuyers often need. A 2022 Urban Institute report found that just 35% of home sales for less than $100,000 were financed by a mortgage. Builders can’t build cheap enough to generate the loan sizes that fall through the cracks of the mortgage system.
While Garg said the expensive mortgage process is a main factor driving up housing costs, other forces hinder builders from breaking ground on starter homes. Strict zoning laws and builder housing incentives are preventing home construction. Most housing experts point the finger at those barriers when talking about housing affordability, seldom referencing mortgage processing costs as the main culprit.
“You have zoning requirements that have encouraged large lot sizes,” Dennis Shea, a housing expert at the Bipartisan Policy Center, said in a recent interview with Washington Post. “Home builders, particularly in the wake of the Great Recession, where they were very negatively impacted, find it easier to build larger homes that have higher profit margins.”
Still, Garg thinks compressing the amount of paperwork needed to secure a mortgage will give new and low-income buyers a shot at grasping the first rung of the wealth ladder.
The “mortgage is one of the few places where tangibly you are saving money,” he said. “You’re not saving like $9 on a sweater. You are literally saving $9,000 on a mortgage because of the combination of AI and machine learning.”
