August 27, 2009

The Foreclosure Mess
A Proposed Solution

In order to FIX the foreclosure problem one must FIRST understand what continues to DRIVE it.


PROBLEM: Mortgage Renegotiation is ONLY available to homeowners who took out risky ARM's (Adjustable Rate Mortgages).

PROBLEM: Prudent homeowners with substantial equity in their homes who opted for conservative 30 year fixed rate mortgages, but are struggling in the current economy, are now unable to access the equity that would permit them to significantly lower their monthly overhead.

PROBLEM: Simply renegotiating mortgages doesn't solve problems. Enabling homeowners to access their own hard earned equity DOES.

PROBLEM: A significant number of homeowners who were in good financial shape before the recession have already tapped, and by now have exhausted their nest eggs.

PROBLEM: In the current market, once a credit card payment has been missed, interest skyrockets. Many homeowners and small business owners are desperate to cut their usurious 30% credit cards in half, pay off the balances and switch to debit cards in order to lower their monthly overhead and live within their means.

PROBLEM: Traditional Lending Institutions have made it abundantly clear that they have no interest in issuing home mortgages unless the borrower has perfect credit.


CASE STUDY: John and Marsha Smith, small business owners, age 72 and 62 respectively, refinanced their home five years ago in order to upgrade and renovate. They currently have 25 years and $175,000. left on a 30 year 7% fixed rate home mortgage. A current appraisal puts their updated and well located home value at $450,000. While John is recovering from an unexpected bout of surgery, John's monthly Social Security check and the income from Marsha's own small business are now the family's sole source of income. John and Marsha have no credit card debt, and their vehicles are owned free and clear. John and Marsha have been seeking a modest 55% loan to value refinance.

Marsha has told John that if they can obtain 5% interest financing for 30 years, she can keep their current monthly mortgage amount the same as it is now, while pulling a sufficient amount of equity from the home to pay off their children's college loans, and pay off the balance on earlier inventory acquisitions.

By doing so, Marsha explains that they can reduce their own current monthly overhead by $1000. per month, and at the same time, put money back into the local as well as the national economy.

The problem is that John and Marsha's mortgage broker has announced that as a result of John's illness and their resultant late payments, they can no longer qualify for a traditional mortgage.

John and Marsha have carefully researched and rejected every other alternative suggested by the mortgage broker, including Reverse Mortgages, as not being in their best interest.

Without the refinance, however, John and Marsha and MILLIONS of other homeowners and small business owners like them, are rapidly becoming overwhelmed in this economy.

Unless a viable alternative presents itself, foreclosure statistics will continue to rise and John and Marsha could find themselves living under an overpass while their hard earned $275,000. in equity is gobbled up in a foreclosure by Countrywide/Bank of America or the like.

John and Marsha are well educated Seniors who make it a point to do their homework.

They already realize that they may eventually want to transition to a private Life Care/Retirement community and understand that those who do are routinely required to sign over to that facility all of their worldly possessions. Without sufficient cash or equity, they will be turned away.

They understand that Reverse Mortgages, which are limited to approx. 39% ($175,500) of their home's current ($450,000.) appraised value, (from which 39% their existing $175,000. mortgage balance must immediately be satisfied), simply siphons off all of their hard earned $275,000. equity without yielding any cash to satisfy other obligations, leaves no safety net, and just doesn't make good financial sense to them.

Does a logical financing vehicle exist which is not currently being offered in today's market? Yes

SAM's - Shared Appreciation Mortgages

A shared appreciation mortgage in which the lender agrees to an interest rate lower than the prevailing market rate, in exchange for a share of the appreciated value of the collateral property is either not currently being offered, or if it is, it's a Mafia-like arrangement demanding a 40% or greater future equity appreciation position.

(The Bush Administration's so-called "Hope For Homeowners" program is an oxymoron. It simply kicks people when they're down. It demands closing costs, (plus mortgage insurance pegged at 3%, of home value), along with the homeowner's current equity plus 100% of future appreciation if the home is sold within one year, leaving the family on the street with absolutely nothing. The "Hope For Homeowners" program takes 50% of future appreciation if the home is sold in 5 years. )

Not much in the way of "Hope" for Homeowners with those terms.

But......A wide-ranging loan program with a 20% future equity appreciation participation would solve much of the country's foreclosure problem and would help jump-start the economy.

Would John and Marsha be willing to exchange 20% of their home's future appreciation in order to refinance at a favorable rate with a SAM now? Unquestionably.

Since they would still own both the home and 80% of future appreciation, would they continue to maintain, upgrade and improve the home? Absolutely.

Would they be willing to pay a slightly higher than average origination fee for the privilege of refinancing at a favorable rate now? Yes.

The ongoing success of a SAM REFINANCE vehicle will depend upon it being viewed as a win/win solution for both the borrower as well as the lender. This means that the loan product has to be viewed by the lender as a conservative, well secured investment generating a solid rate of return.

On the other side of the fence, from the borrowers point of view, yielding 20% of future appreciation can be mentally and emotionally justified.

It is important to understand that 20% is a key number.

Take more than 20% of future appreciation away, and the homeowner simply loses heart and has zero incentive to either maintain or improve the property, both of which are critical components of property appreciation.

The SAM recipient either looks upon this refinance option with gratitude or resentment, based on what is perceived to be either a reasonable or a usurious percentage of future appreciation required by the investor.

The SAM option permitting a refinance allowing homeowners to pull hard earned equity out of their home with a homeowner yielding 20% of future appreciation represents a real, easily initiated solution and such loans could be Federally insured.

To further ensure lenders safety, the LTV ratio could be capped at 60% with additional safeguards built in.

The point of the exercise is SELECTIVITY. Choosing to refinance properties in which sufficient equity already exists could be viewed as the answer to a maiden's prayer.

AARP would jump on the bandwagon in a heartbeat, because the program greatly benefits those who are innocent victims of the recession.

Mortgage brokers would be doing backflips, because unlike reverse mortgages, which rely on smoke and mirrors to induce participation, this is a refinance product they can sell with a clear conscience.

From an investors point of view, this is a conservative, secured investment, and overall, a win-win proposition for the economy.

The SAM was pioneered by banks in the U.S. some 40 years ago, but it has been allowed to languish due to an archaic, IRS-imposed block. (The IRS hasn't ruled whether such a contract is a mortgage because it combines elements of equity and debt.)

This block could be removed at the stroke of the Treasury secretary's pen.

Almost 75 years ago, in the depths of the Great Depression, the nation faced a housing market collapse even more brutal than today. The federal government responded with a strategy that allowed homeowners to keep their homes and kept the bottom from falling out of the real-estate market. Unprecedented at the time, the 30-year fixed rate mortgage has since become the gold standard in markets around the world.

Today, facing a similar collapse, the federal government needs to be equally bold. SAMs are the new deal in housing that our children need.


WALL STREET JOURNAL ARTICLE: Facilitating Shared Appreciation Mortgages to Prevent Housing Crashes and Affordability Crises

By Andrew Caplin, Thomas Cooley, Noel Cunningham, and Mitchell Engler

(Mr. Caplin is an economics professor and co-director of the Center for Experimental Social Science at New York University. Mr. Cooley is dean of the Stern School of Business at NYU. Mr. Cunningham is a law professor at NYU. Mr. Engler is a professor at the Benjamin. N. Cardozo School of Law.)