The Mortgage Professor: Allying homebuyers, investors could be tricky
Matt York, ASSOCIATED PRESS
A new company called Primarq promises to give investors looking for better yields access to home appreciation, diversification across many individual transactions, and freedom from legal and operational details, which would be handled by Primarq. The promise to homebuyers and homeowners looking to refinance is that accepting an equity investment would reduce the size of the mortgage they would need, reduce the interest rate, reduce or eliminate mortgage insurance, and reduce their monthly mortgage payment.
It sounds like a great idea, a business marriage made in heaven — which makes one wonder why nobody ever thought of doing it before. Or perhaps they did and decided that it wouldn’t work.
Implementation faces many challenges, and it remains to be seen whether Primarq can overcome them. Here are some of the major ones.
—Association with defunct shared appreciation mortgage, or SAM, programs: Under SAM programs in the U.S. and U.K., borrowers received a rate reduction from lenders in exchange for a share of property appreciation. The lender was also the investor.
Lenders writing SAMs in the U.S. evidently gave up on them because the appreciation rate was too low, while in the U.K. borrowers rebelled because the appreciation rate was too high. This divergent experience arose because home prices are highly variable and the SAM programs were enacted at different times in the two countries.
The Primarq program differs from SAM programs in many ways, including the fact that equity investors in Primarq, but not SAM lenders, share in the downside risk. Such differences might make the Primarq program more robust in the face of pronounced and prolonged house price changes, but this requires further study.
—Existing restrictions on acceptable fund sources: Fannie Mae, Freddie Mac and the Federal Housing Administration have detailed regulations governing the portion of the down payment that must be provided directly by the borrower, and acceptable sources of other funds that might be used to supplement the borrower’s own funds. These include personal gifts, donations from acceptable entities, employer assistance and community second mortgages. Investors looking for a return in the form of appreciation do not appear in the current rules.
The reason seems to be a concern that because part of any change in value will belong to the investor, the owner/borrower will have less incentive to improve the unit, which would increase risk to the mortgage lender or insurer. Under the Primarq plan, however, the homeowner would receive credit for any capital improvements and would not have to share the increase in value with the investor. In addition, homeowners will be required to retain at least 50 percent of the equity. With a $100,000 house, the borrower who is looking for an $80,000 mortgage could accept an investment no larger than $9,999.
Whether these provisions will satisfy the agencies remains to be seen. A possible alternative is one or more portfolio lenders who will make these loans to hold. Primarq is “talking to” both the agencies and portfolio lenders.
—Disclosures to consumers: Many borrowers don’t understand how mortgages work, disclosures mandated by government are poor, and injecting a third party into the process complicates it further. This poses an enormous challenge to Primarq, which can’t afford to wait until the government forces its hand by mandating more useless disclosures. Borrowers need a good sense of what they are receiving in the form of lower mortgage costs and payments, and what they are giving up in equity to get it. And they need this under different market price and holding-period scenarios.
Primarq said it is working on a disclosure statement that will include such features, and will send it to me when it is ready.
—Disclosures to investors: To diversify its risk among many individual transactions, investors cannot afford to investigate each deal themselves. Primarq must provide them with ready access to the information they need. The Internet provides wonderful tools for this purpose. It enables Primarq to engage a number of third-party vendors of the types of information that investors in homes will want, including investment returns under different assumptions regarding appreciation rates and transaction life.
—Providing assurance that investors get paid: Mortgages are recorded as a protection for lenders. The borrower can’t sell and skip town with the proceeds, because the lien must be paid before the sale can be executed. A third-party investor requires the same protection, which means that their interest in the property must be recorded. It is recorded as an ownership rather than a creditor interest, but the result is the same. The property cannot be sold without their participation.
Since it is not practical for every individual investor to be involved in the sale of a property, Primarq will record its ownership through a trust, which will be a proxy for the investors. I doubt that there are any legal barriers to doing this, but I am not a lawyer.
Some of the issues raised above are obviously more challenging than others. I toast the effort, which will be helpful to all parties if it works as intended.
ABOUT THE WRITER:
Jack Guttentag is professor emeritus of finance at the Wharton School of the University of Pennsylvania. Comments and questions can be left at http://www.mtgprofessor.com.
©2013 Jack Guttentag
Distributed by MCT Information Services
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