Many lenders have not budged from their prepayment penalties – the practice of charging a significant fee if the borrower refinances or sells within a specific period of time – even though other borrowers with inferior credit and poor payment histories have more attractive options.
Now, a private company is offering lenders a chance to help borrowers who continue to make their payments even though their loan balance is far greater than the value of their home. The plan could begin to reduce the mounting number of “underwater” borrowers who have simply walked away from their homes.
New Jersey-based Home Value Group does not buy mortgages. The company makes its money by charging a lender or institutional investor a fee for keeping borrowers in their homes by offering the homeowner an incentive to stay put, known as a “Responsible Homeowner Reward.” The reward, about 10 percent of the mortgage amount, is paid to the homeowner when the house is sold or paid off. By doing so, the lender saves the costs of foreclosure and the difference between what it is owed and the foreclosure-sale price.
For example, a borrower with a $300,000 mortgage now owns a house worth $200,000. The lender does not want that borrower (and other customers) to walk away from the loan and face the prospect of losing $100,000 and trying to sell the home for $200,000. The lender signs up for the Responsible Homeowner Reward program. If the homeowner keeps the loan current, they receive $30,000 when the house is paid off. If the house is sold for less than the loan amount, the $30,000 is applied to the difference between the sales price and what is owed.
Home Value Group will not disclose the lenders-investors that are now participating in its program. Rosalia Scampoli, a spokesperson for the program, said all residences are eligible, including second homes, vacation homes and rental properties. The decision to offer an award is up to the participating lender.
Given the rising number of owners walking away from underwater homes, Home Value Group is betting that more and more lenders will try to keep “strategic defaults” in their homes. According to First American Title Insurance Company, more than 11.3 million, or 24 percent, of mortgage holders have negative equity, and the numbers are rising.
The magic question becomes, will owners view the reward as enough of an incentive to continue making their payments? Some areas may not see positive equity for some time. While the Puget Sound area is in a favorable position compared to the rest of the country, borrowers in Detroit, Phoenix and south Florida may never get back in the black.
Alex Edmans, an assistant professor of finance at the Wharton School at the University of Pennsylvania, is an equity stakeholder in the Home Value Group. Edmans wrote that “since default is a discretionary, rational decision made by the homeowner, an effective solution must provide incentives for the homeowner to choose not to default, rather than welfare to enable him to make payments… . The decision to default is driven by negative equity rather than the loan’s affordability, the solution must target the home owner’s balance sheet rather than income.”
The “welfare” reference has brought up the philosophical debate about how much should be spent on federally backed loan modifications. The Home Value Group solution appears to be based on the idea that many underwater home owners would “prefer to do the right thing” and repay the debt they signed up for.
However, some home owners who were once willing to do so see their financial hole too deep to continue with their home payments. Still others are so upset with the financial behavior of major lenders, they see no reason to continue being good soldiers.