Shared equity as an approach to foreclosure prevention is an idea that lots of people are talking about. However, most of the strategies currently being discussed require the government to take big financial risks and expose lenders to huge write-offs and losses. There is a way to employ shared equity that offers a win-win opportunity for homeowners and lenders without government intervention. It's called a Partnership Mortgage, and works in the following way:
- Lenders would determine the maximum amount of the mortgage that can be prudently underwritten, given current loan-to-value and homeowner affordability constraints. The homeowner would make regular monthly payments on this portion of the existing mortgage balance.
- The remaining amount of the existing mortgage balance would require no current payments of principal or interest from the homeowner. Instead, this portion would be due upon resale of the property, along with a share of appreciation in the home over its current value.
When the approach is done right, homeowners will typically be able to pay back the remaining principal balance simply from the build-up of equity as they make payments on the current-pay component of their mortgage. They’ll keep their home - and will still build real equity for the future. Meanwhile, lenders will recoup what they would have written off. Even in scenarios with slower-than-normal house price growth, they can earn a decent return on their principal –enough to motivate them to hang in there with the homeowner.
Partnership Mortgages are not going to be the solution for every delinquent mortgage. Nevertheless, for many homeowners – such as many of the 1.5 million subprime borrowers facing an interest rate reset in 2008 - they present an attractive option for staying in their homes while promising a fair return for lenders.
Eric Hangen is president of I Squared Community Development Consulting, Inc.