Home Equity Sinks To Record Low Triggering More Foreclosures

Home price declines are now so severe they have erased all home equity for more Americans than ever before. Home equity numbers have been recorded starting at the end of World War II and are now at there lowest level in history. For many home owners, their mortgage debt actually exceeds their home’s value…what is called negative home equity.

Journalnow.com reports Mark Zandi, chief economist at Moody’s Economy.com, estimates 12.2 million home owners by the end of this month will have no or negative home equity. That is 1 out of 4 homes with a home equity problem just waiting to slip into foreclosure.

A problem just as big as “no home equity” I want to address here is:

“What To Do About It”

Mr. Zandi has a plan he calls the Home Appreciation Mortgage Plan. In his plan, HAM for short, the government should take quick and aggressive action to modify mortgages to allow home owners to stay in the homes.

Here are the basic tenets of HAM:

1. Lenders must down mortgages to 90% of appraised value modifying the 1st into a new “smaller” loan and a non-amortizing HAM second mortgage. Since the new smaller 1st mortgage will be fixed at current rates and the second will have no payment…home owner’s could get the breathing room they need to stay in the home. FHA will insure the HAM second to protect the lender.

2. As compensation, lenders get to “share” in the future appreciation of the home. This is known as a “shared equity agreement” or a “shared appreciation agreement” in the industry. Not a new concept really, since investors and owners or parents and their children use shared equity agreements all the time.

3. The equity is then shared between the borrower and the lender when the house is sold or refinanced anytime down the road between 3 and 10 years. Proceeds from the sale go first to pay FHA HAM fees, then the principal balances of the 2 HAM mortgages, then the equity left over is now used to make the original lender whole…remember them? The original lender had to take a “write down. So the home owner must share the remaining equity 1 to 1 with the old lenders. So if the equity left is $60,000, and the original lender had to “write down” $20,000 to put the HAM loans in place…then they would get their $20,000…leaving the home owner with $40,000. If there were 2 original lenders, they split the proceeds 60/40 until whole again.

What Do I Think of the HAM

I think it is an elegant solution. Would it work? Sure it would if it ever got implemented. But reality is it won’t.

Why?

Because the one thing Mr. Zandi forgot about is the greed and impatience of mortgage lenders. They don’t care about borrowers or lowest home equity since they began keep the numbers. They care about profit. The system today, is foreclose…resell at a loss…and claim your insurance from FNMA, FHA or a private PMI company to get whole.

They get whole in a year or two….not 3-10 years…and they don’t have to put an entire new staff together to calculate write-downs and modify servicing agreements. There is not a bank lobbyist worth his salt who’d every let this plan get to committee, much less get a vote.

Nice try Mr. Zandi…but you have no idea who you’re messing with.

Now What Do We Do Since HAM Is Out

Folks, don’t count on any government program to avoid foreclosure. As you can see the HAM program is assuming you can get out of your “no equity” problem simply by waiting it out. This is true. So if you have a decent fixed rate mortgage(s), simply wait it out. The equity will return.

If you made the mistake of getting adjustable rate mortgages and the payments are already or soon to start adjusting…grab a calculator and estimate just how bad it could get. If it is bad enough, you need to refinance into a fixed rate or foreclosure is a foregone conclusion.

Which brings me to my solution:

The Private Shared Equity Second Mortgage

Do the HAM on your own. I call it the Private Shared Equity Second Mortgage. Get Mom and Dad or an investor or somebody with cash to enter into a shared equity arrangement with you to “buy down” your loan to a LTV you can afford on a fixed rate basis. Mr. Zandhi’s formula was 90%. Let’s use that number for an example.

Say you bought a $100,000 home with no down payment a year ago with an ARM first mortgage rate of 5.5% with a payment of $567.78 P&I. You know the ARM will adjust in a year…and has a first adjustable rate cap of 5%. So even on the first adjustment the payment could go as high as $914.74 using a 10.5% rate. This is causing you to consider walking away. After all to have your payment possibly double is untenable.

You need to refinance but you realized your home has lost 10% of it’s value…only worth $90,000 today. Instead of walking away or waiting for the government, you decide to take action and implement your own version of HAM.

Find someone with cash…a relative, friend, etc. …set up a “shared equity second mortgage” for the amount it takes to buy you down to a fixed payment refinance you can afford. In this example, it looks like this:

Need $10,000 to cover loss of value over the last year.
Need another $10,000 to buy down first mortgage so you can afford the payment.

Let’s look at the new LTV: 1st mortgage balance 100K…bought down with 20K shared equity money….now 80K. Current value 90K. 80/90 = a new refinance LTV of 88%…just enough room to add refinance closing costs and not exceed 90% LTV.

Let’s look at the new payment: Current rates say 6%, 30 year fixed = $599.55…now that payment you can afford since it’s only $22 more than you are paying now. There is no monthly payment on the Shared Equity Second Mortgage. This is what Mr. Zandi calls a “non-amortizing second mortgage”.

Let’s look at the future: 5 years down the road the house is worth $150,000…time to sell or refinance. Your shared equity partner and you split the excess equity in a fair prearranged percentage….50/50…60/40…whatever. Let’s say 50/50.

Sale Price 150,000 - mortgages 100,000 = equity $50K If the split was 50/50 …you keep $25K and give your partner $25K. Your partner lent you $20K…five years ago…received no payments, but now he gets his 20K back and an additional $25K equity. Not a bad deal for your partner.

You get to keep your house because you were smart enough to read this article, take action, and put your shared equity mortgage together to buy you the breathing room to let the market come back…and it will. It always does.

BTW: You’ll need your shared equity partner to give you the money…put it in your bank account for 60 days prior to refinance to get it seasoned. This way they won’t ask you where it came from during the underwriting of the refinance loan. If they get wind you borrowed it, the jig is up. So complete the refinance with seasoned funds, then have the shared equity second mortgage note recorded a week or two after the refinance closing.

Normally I don’t teach folks how to “game the system” but in this case I’m save you, the first lender, the refinance lender, and the country from a banking system that let us all down. We are not passing any greater risk on to anyone…we are reducing risk for all. Desperate times call for desperate measures…and this is the most benign of all the rule bending that’s been going on in this industry for the last decade….so I can live with it if you can.

Grandma Saved and Savior Simultaneously

These shared appreciation agreements can be used with retirement aged folks in conjunction with a reverse mortgage as well. Say grandmother has a ton of equity, but also has a need for income and is having trouble making the existing mortgage payment. She taps her home equity using a reverse mortgage for the $20K cash you need, signs a shared equity arrangement with you. In addition to your cash, she also pulls enough cash to pay off her existing mortgage eliminating that monthly payment. She then can also choose to receive a monthly payment for her remaining equity to offset her living expenses.

AARP has a great reverse mortgage calculator setup to show folks what they can expect to get lump sum and monthly based on age, home value, etc.

This is a super win-win for both of you. She gets out from under a mortgage payment, gets a lifetime monthly income to boot…and you get your shared equity money so you can keep your home. If she was going to give you money in her will anyway…she could stipulate upon her death the shared equity mortgage is to be cancelled and you never have to share your equity after all.

Now that is not only an elegant solution…it’s actually workable.

Now quit looking for the government or the lender to save you from foreclosure…do it yourself! You now know how.

Good Luck!

Author: Rob K. Blake
Published June 12, 2008