Thursday, April 15, 2010

When right-to-rent meets principal reduction

Original posted on Reuters by Felix Salmon:

What happens when you cross right-to-rent with mortgage principal reductions, and turn the whole thing into an entirely voluntary private-sector program with no government involvement whatsoever? It might look a little bit like American Homeowner Preservation, a for-profit company which has a very interesting idea for keeping people in their homes.

The details can be found here: the core of the scheme is where AHP persuades a lender to accept a short sale on a home. That’s the principal-reduction bit; the right-to-rent bit then kicks in when the buyer of the home — an AHP client, along with the seller — agrees to rent back the home to the former owner at a low, affordable rate which can’t be more than one-third of the tenant’s income. Rent increases by 5% annually for five years; at any point, the tenant has the option to buy back the home at a predetermined price which rises year by year; tenants get financial counseling to enable them to do that.

The buyer can sell the home at any point in the first five years subject to the existing lease and option; after that, it’s put on the market and any profits over and above the option price get split equally between the buyer and the tenant.

If everything goes according to plan, the buyer makes healthy returns: here’s one financial projections sheet which foresees returns in the low double digits. And the homeowner ends up buying back their own home for much less than they originally bought it for. Meanwhile, AHP makes relatively modest fees of a few thousand dollars along the way.

I don’t know much about American Homeowner Preservation, and their website could use a bit of work. But in principle, I think there’s a very good idea here. Any bank dealing with AHP is going to want to make very sure they’re getting a genuine market rate for the house in question, but so long as that’s the case, and the bank is open to short sales in principle, this looks like a win-win for all concerned. The owner gets to stay in their house, the bank gets to avoid the expense of foreclosure proceedings, and the investor gets decent returns. Clever!

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