The foreclosure crisis continues to spread across the United States, with news that the malaise has moved beyond its previous epicenters in Nevada, Florida, and California. Many banks that halted foreclosure proceedings in the past month or so have restarted the process, and many homeowners report making little headway with banks in modifying their loans. When foreclosure appears imminent, what can homeowners do?
If they live in certain Boston neighborhoods, they can turn to a new nonprofit called Boston Community Capital (BCC), which buys foreclosed houses from banks at market rate and sells them back to the homeowners. By entering the process after foreclosure, BCC is taking a unique tack on helping foreclosed homeowners stay in their houses.
But if people can afford the cost of their home at current market prices, why does the bank foreclose in the first place? Why don’t they modify the loan down to the market price? After all, banks can lose up to 50 percent of a house’s current market value by putting it in foreclosure.
“An existing bank wouldn’t want to do this because it would really change the behavior of the rest of their borrowers,” said Brian Melzer, a professor of finance. “One of the threats to get people to pay their mortgage is that they’ll lose their home. If people think they can just get the loan written down and stay in their home, the bank won’t be in as good of a bargaining position.”
But BCC is. As a third party, they have no obligation to purchase the home and no prior relationship with the bank. To purchase a foreclosed house, BCC and its partners take a three-pronged approach. First, community groups protest the foreclosure, pressuring the bank to sell to BCC and to allow the homeowners to stay in the place until the house is sold. Harvard Legal Aid, a legal service for low-income people, simultaneously works the lawyerly angles to stall the foreclosure process. While all this is taking place, BCC evaluates the homeowner’s loan-worthiness in advance of making the bank an offer.
If the homeowners pass muster—less than half do—BCC will approach the bank and try to purchase the home at market price. If BCC succeeds, they sell the home back to the owners with a 30 year mortgage and a few caveats. The mortgage is for 125 percent of the purchase price as a hedge against default. BCC also demands half of any profits if the homeowner decides to sell. This gives BCC an equity stake in the home, a unique arrangement which allows the group to charge a lower interest rate, Melzer said.
BCC’s approach is also unique because the buyer of the property—the homeowners—know everything about the condition of the home. Foreclosed homes are typically gambles for regular buyers. In the best case, the previous owners may have put off needed repairs. In the worst case, the home may be trashed, with appliances missing or copper piping ripped out of the wall and sold as scrap. If the current owners are the buyers, though, they have an incentive to keep the house in good order. “That’s a reason why Boston Community Capital would be better positioned to do this than any old investor who buys foreclosed homes,” Melzer said.
There’s good news for the people who make it through BCC’s rigorous vetting process. Ninety percent of BCC’s offers are accepted by the banks, according to a PBS Newshour report on the organization. Still, there are some cases in which BCC loses the sale to a higher offer. At that point, there is little more BCC can do —they do not buy houses for more than market value as that would threaten the organization’s financial stability.
Convincing the banks
BCC also addresses the tedious and often dead-end loan modification process. Modifications require both possession of the loan and complete documentation, both of which the banks do not always have, as we have recently learned. Furthermore, the banks “don’t have the ability to do a massive renegotiation. It takes a long time for them to do that. They don’t have the capability,” said Paola Sapienza, a professor of finance. Community banks may be more willing to renegotiate a loan, but many have resold the loans to a third party, she added.
There are also internal policies that can get in the way of an amicable resolution. “The way the bank is organized, it’s going to be very difficult to issue a mortgage to someone who has just defaulted on their loan,” Sapienza said.
But in the meantime, many people delinquent on their payments will likely be able to stay in their homes for quite some time. Foreclosing on a house is both time consuming and expensive, due to legal costs and the low sale prices of foreclosed homes. Plus, banks have been valuing delinquent mortgages above market value. Foreclosures and loan modifications force banks to update their balance sheets with the lower, albeit more realistic prices.
Foreclosure is real problem in hundreds, maybe thousands, of communities, and some see BCC as a model for similar programs in other areas. And given its community-focused idiosyncrasies, proving a template may be BCC’s best chance to influence the foreclosure crisis outside of Boston. Because its primary role is one of philanthropy rather than profit, BCC’s model may not be very scalable, Melzer said.
“It’s an interesting model to imitate,” Sapienza said. “If done in this way at the community level, I think yes, it definitely can work in other places.”
Photo by Adam Pieniazek.