Homeowners who are severely underwater but want to keep their homes often have few options. They can try to get their lender to modify their loan, but with Federal Housing Finance Agency head Ed DeMarco refusing to allow principal reductions on loans owned or guaranteed by Fannie Mae or Freddie Mac, chances are slim that they will be able to get the balance reduced. (Less than 3% of loan mods under HAMP involve principal reduction.) And unless they are lucky enough to be able to eliminate (“strip”) a second mortgage in bankruptcy, they probably won’t be able to use bankruptcy to help them get back to break-even, either.
That usually leaves them with the option to hang in there until some day in the future when their home is worth more than they owe. Many homeowners who aren’t willing or able to ride out years of uncertainty are instead choosing to “strategically default,” or walk away from their homes.
But there is another option. It’s called “strategic refinancing.” Pioneered by HomeLiberty, a Northern California-based start-up, it buys the homes of those who are severely underwater and sells them back to those same homeowners at or below market value. It allows homeowners to eliminate tens of thousands of dollars in mortgage debt while staying in their homes.
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Mark Moore came up with the idea for HomeLiberty after helping a family member with her upside down home loan. A serial entrepreneur, Moore said he “tried not to do something in real estate,” but the opportunity to solve a huge problem — a $1.2 trillion problem according to Zillow — wouldn’t stop nagging at him.
After extensive research, which included reaching out to attorneys and regulators to make his program was on the up and up, he launched HomeLiberty with co-founders Patrick Smida and Patricia Hanratty, both of whom have extensive backgrounds in the home financing industry.
HomeLiberty only helps homeowners who have documented incomes and owe far more than their homes are worth. It approaches the lender, offering to buy the home for less than the current market value. (It also frequently purchases homes for cash at foreclosure auction or post auction.) If successful, HomeLiberty immediately sells it back to the homeowner at a predetermined price, at or near market value. The company then finances the purchase with a new private mortgage loan of up to 90% of the appraised value. “It’s not a rent-to-own deal,” says Moore.
If the deal gets done, the homeowner owns the home and has a new loan, but is no longer upside down. From there, the deal gets sweeter. The first 13 on-time payments go entirely toward principal, with the goal of further increasing equity. (Payments are fixed for the life of the loan, so there is no payment shock in month 14.)
The new mortgage isn’t cheap. Most borrowers will pay 10 — 12%, rather than the 3-4% borrowers who qualify for the best rates can get today. But the combination of eliminating debt in the sale, and the fact that the first 13 payments are interest-free means homeowners can build equity much faster than they would have if they kept their old loan. “In 13 months our customers pay down more principal than they would in five years on a (traditional) 4% loan,” says Moore.
An additional benefit is that homeowners remain in their homes the entire time this process is taking place. That means the home is more likely to be maintained in good condition. “I don’t want to remove a tenant,” says Moore.
[Related Article: Underwater On Your Home? Your Six Options]
Helping the Huxtables and the Cleavers
Homeowners are screened carefully to make sure they can afford their new loans. But unlike traditional mortgages, high FICO scores aren’t required. “Our customers tend to be very good borrowers with bad FICO scores. They are good people,” he insists. “I ask most people to imagine the typical underwater homebuyer. They will describe people who are struggling. The truth is the average underwater homeowner is the Huxtables or the Cleavers.”
HomeLiberty is currently is focused on California and Arizona, both of which are “non-recourse” states, meaning that homeowners can often walk away without risk of being sued for a deficiency. That gives it negotiating leverage, and does raise the question of how easy it will be to expand in other states.
There is also a question of how scalable the business model is. Moore insists that there’s plenty of room for growth, and one reason is that homeowners can typically get their loans below 80% loan-to-value fairly quickly. If their credit scores are strong enough, they may be able to refinance into a traditional loan in just a few years. These loans carry no prepayment penalty, so homeowners are free to refinance anytime. When they pay off their loans, those funds are then available to lend to other homeowners.
I asked Moore the obvious question: If banks are going to sell these homes to HomeLiberty for less than what’s owed, then why don’t they simply write down the principal instead? He laughs. “Banks are not going to write down principal until the market forces them to do so. It’s the concept of ‘eating your baby.’ They are not going to cannibalize underwater but performing loans.”
One of the reasons the program works, he says, is that HomeLiberty is making the lender an all-cash offer that’s usually more than what other bidders for the property will pay, and can close in as little as 48 hours. That means a risky loan is off the lender’s books with a minimum of hassle.
So while pundits in Washington debate over the moral hazard of reducing principal balances on mortgages, HomeLiberty is forging ahead, helping homeowners save their homes one at a time.
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Image: Bill Ward, via Flickr