Five years after the housing market peaked, the mortgage mess remains a significant drag on the economy. Banks, policymakers and investors have yet to figure out a way to stop the cycle of massive foreclosures and the fire sales that inevitably ensue. In September, foreclosures and short sales accounted for 30 percent of existing home sales.
The calls are rising, from all points of the political spectrum, for mortgage modification — i.e., figuring out a way to let people stay in their homes even if they can't afford the current mortgage payment. While banks, the Obama Administration and the taxpayer-owned mortgage giants Fannie Mae and Freddie Mac dither, one non-profit lender is taking matters into its own hands. Boston Community Capital, which has been active in the region for 30 years, last year set up the Stabilizing Urban Neighborhoods (SUN) initiative. The plan? Buy properties back from banks who aren't willing to modify. Then resell them to the owners who were in danger of defaulting or who had already defaulted —- at a much lower price and with a better mortgage. And all while delivering 4.25 percent annual returns to investors. The goal, aside from keeping people in their homes, is to stabilize neighborhoods.
Since 1985, BCC has invested more than $650 million in low-income communities, and financed more than 11,100 affordable homes. The organization's CEO, Elyse Cherry, was a partner at the blue-chip law firm Hale and Dorr who specialized in commercial real estate and who knows her way around structured finance.
Several years ago, she saw trouble developing in lower- and middle-income neighborhoods around Boston. In seven inner-city neighborhoods, the average mortgage was $323,000, while the average income could only support a $150,000 mortgage. "On balance, people had twice the mortgage they could afford," Cherry says. Then came the bust. In certain neighborhoods, home prices have fallen up to 50 percent. "It's a nightmare if you're paying the mortgage," says Cherry. "But it creates an opportunity."
Cherry decided to start a mortgage lender that would buy back properties from banks at steeply discounted prices, and then underwrite new 30-year fixed-rate mortgages for customers who could afford the payments. (In the accompanying video, Cherry and I discuss the SUN program.)
To raise funds, BCC in May 2010 sold $20 million in five-year bonds that pay 4.25 percent annual interest. That's a pretty good return, considering how low interest rates have fallen. Amy Domini, a money manager in Boston with long-time expertise in socially responsible investing, took about $1.1 million of the offering for some of her clients. (Domini manages $950 million for high net worth individuals in private accounts.) While the bonds don't trade, Domini was willing to buy because she knew BCC's track record, and because of the protections BCC installed for investors. Of the $20 million raised in the bond, $4 million immediately went into loan loss reserves. "They've set aside 25 percent at the start in case there are losses," says Domini.
In other words, of the $20 million raised, BCC will lend out only $16 million, at 6.25 percent. BCC also takes other steps to ensure repayment. BCC takes a diametrically opposed approach. It approaches the bank and offers to buy it at the market price. "And if we have a buyer that can afford it at that price — plus significant reserves — we'll sell it," Cherry says.
In 2006, Lydia Smith and her husband, who were both full-time workers, bought a two-bedroom cape in Hyde Park, Massachusetts. Upon closing, they had two mortgages for a total of $329,000. "We didn't know we were getting two separate loans," Smith says. "When I asked about it at the closing, they gave us a runaround." One of them had a large balloon payment. The couple was able to make the $2,550 monthly payments for a couple of years, but when Lydia's husband, a custodian, got injured and was unable to work, they began to fall behind. America's Servicing Company, the Wells Fargo unit that serviced the loan, wasn't particularly responsive to efforts to modify.
BCC bought the house from the bank in February 2010 for $165,932. Then it turned around and wrote a new mortgage to the Smiths for $214,000 —- the price of the home plus a 25 percent loss reserve, plus a several thousand dollar reserve for repairs. The upshot: The Smiths now pay $1,685 per month for the mortgages, taxes and insurance, a 44 percent reduction.
The house is still underwater, but the homeowner —- and hence the neighborhood -- is more stable. And while it gives borrowers a break, BCC also asks plenty of them. It requires people to make 26 bi-weekly mortgage payments instead of 12 monthly ones. "If they get paid on Monday by automatic deposit, they have to pay us on Tuesday," says Cherry. "We've tried to create a circumstance where the mortgage is the first bill paid." The 26 weekly payments force borrowers to make an extra month's payment each year, which they can use either to write down the principal or place in a reserve for a rainy day.
There's a final piece that helps protect BCC from some of the charges that it is simply encouraging and abetting moral hazard. If the homes appreciate over time, the mortgage agreement provides that BCC received 50 of the gains. BCC has committed to use any such gains to spruce up neighborhood parks, or fund college scholarships."When you explain that to the neighbors, they get it," says Cherry.
Of course, to a degree, such efforts can be seen as rewarding irresponsible behavior. But proponents insist we take a broader view, and think less about the individual and more about the impact of foreclosure on neighborhoods. As investor Amy Domini puts it: "What good does it to do a neighborhood to have ten foreclosed mortgages and ten properties out for sale, and ten people living in cars on the street?" And while one solution may be for investors to purchase homes and rent them out to residents, Cherry notes that homeowners tend to maintain their properties better than renters.
Mortgage modification is a messy, complicated business. Groups like BCC are trying to solve a problem that was created on a wholesale level —- mortgages shoveled out by machines —- on a retail level. And there are serious obstacles. The first is scale. So far, BCC has returned 125 homes to owners through its SUN program, with only one default. It would like to expand in Boston, and in other cities, but there's a funding issue. BCC is borrowing for five years and lending for 30. Cherry reasons that, if the bonds perform well, she'll be able to securitize income streams, and plow the proceeds into new loans.
The second problem is more daunting. It will come as no surprise that one of the institutions with the most to gain from mortgage stabilization simply isn't interested in BCC's effort. "Freddie Mac won't work with us," Cherry says. "They've taken the position that any property that ends up in the hands of the original owner is a non-starter." To work with Fannie Mae, BCC must hold onto a property for six months after buying it before writing a new mortgage. "We've managed to do a grand total of thirteen with Fannie."
Daniel Gross is economics editor at Yahoo! Finance.
Email him at email@example.com; follow him on Twitter @grossdm.
His most recent book is Dumb Money: How Our Greatest Financial Minds Bankrupted the Nation.