On Tuesday Federal Reserve Chairman Ben Bernanke called on mortgage lenders to “find effective responses to the increases in delinquencies and foreclosures.” His proposal to reduce the loan principal has met with lukewarm reception by lenders. Loss-mitigation arrangements such as principal reductions, interest rate reductions and loan extensions are advantageous to lenders because the foreclosure alternative is extremely expensive. Chairman Bernanke said that lender lose in excess of 50 percent of the principal balance by pursuing foreclosure. Structural issues, such as commitments to investors and borrowers are a road block to many workout plans.
A workout alternative that has not been discussed but which could be useful is a Deed of Trust in Lieu of Foreclosure linked with a Lease with Option to Purchase. With a traditional Deed in Lieu the borrower reaches an agreement with the lender to give the lender his home in exchange (in lieu of) foreclosure. The house remains vacant until it is sold, contributing to community foreclosure blight. The homeowner is forced to move and find rental housing elsewhere. The bank could instead offer the homeowner a long term lease on the house with an option to repurchase at a fixed price in the future.
A Deed in Lieu coupled with a lease option has many advantages. The homeowner is able to avoid foreclosure and stay in the home. Homeowners tend to take better care of a house than a renter, so the house will maintain its value. The homeowner is motivated to take care of the house because he knows when his financial situation has improved, or the housing market has rebounded, the home can be repurchased.
The lender also benefits by avoiding an expensive foreclosure process. Rather than having another empty house on its books, it is receiving lease income from a motivated homeowner. The lease option can be structured so that the rent is affordable to the homeowner. Since this amount will likely be less than the original loan payments, the difference can be added to the option price of the house.
The community benefits also. Homes sold at foreclosure auction puts tremendous downward pressure on home prices. In many cases, this drives the price of neighboring homes below the amount owed on them which contributes to further foreclosures. Dropping property values erodes the property tax base which, of course, causes further problems.
This is an alternative worthy of discussion. It may be a step that can lead us out of this foreclosure crisis.
Ralph Oliver Thompson
California Attorney/Real Estate Broker
