Monthly Archives: June 2006

06/08/2006 FAQ #1: How will SwapRent (SM) and its embedded mortgage product (HELM) help the current defaulting subprime and other mortgage borrowers?

SwapRent (SM) is basically the realization of economic renting while keeping legal ownership for homeowners. It allows the property owners to switch between owning and renting economically in a freely traded market any time they want while keeping the 100% legal ownership of the properties they bought. Homeowners make that decision to switch based on a couple of economic factors. One of them is the cost of owning vs. renting.

The answer to the perennial question of to buy or to rent varies as time evolves. Some time the rental rate is higher and more expensive than buying, other times the reverse is true. It would be nice if property owners can have a choice to separate the legal ownership from the economic interests and hence the financial risks of owning a property, a way to continue the legal ownership and economically switch between owning and renting only economically according to the market conditions. That goal is what the SwapRent (SM) market was designed to achieve. In addition, the economic renting provided by SwapRent (SM) will also alleviate the “moral hazard” issues that real conventional renting usually entails.

In the past few years the fictitious housing affordability in the US was created based on transient short term variable interest rates. When the rates were already trending higher the low income borrowers were still lured into owning by the “teaser rates”. Those subprime borrowers were originally not qualified as owners. They could at most rent to have a shelter to sleep in. They should have been renters to begin with given there was no other viable true housing affordability offered through any conventional shared equity or shared appreciation products in the US that have been around for decades in other countries such as the UK. SwapRent (SM) and its related consumer finance products were originally created to replace those conventional shared equity or appreciation mortgage products, by the way.

Now that they were already hooked as owners and the banks and the RMBS investors are also hooked by hoping that they would continue to be owners it appeared to be OK for a while. But that will not be the case when the interest rates increase or after the rates reset. So instead of letting them default or foreclose which will trigger the real estate market decline and RMBS investor losses etc. SwapRent (SM) could let them afford to continue to legally own and avoid default / foreclosure by economically switching them back to be renters temporarily until the market condition recovers later on. They could switch back to be full owners until SwapRent (SM) contract expires or when they want to unwind or cancel the contract any time before maturity when they have more income later on.

The market will decide where the Generic SwapRent (SM) rates are in a given neighborhood or city. It should be very close to the real average rental rates in that neighborhood to avoid risk-less arbitrage opportunities. The rates will vary according to the maturity terms, i.e. 2, 5, 10, 15 years … etc.

As illustrated in the presentation slides, for a HELM if Generic SwapRent (SM) rate could be at 2% as a starting point and the current mortgage funding cost is at 5% for a 5-year example. There will be an annual 3% differential between the rental payments and the mortgage payments (without even considering credit spread and impound). That means the rental cost is still affordable but the increased mortgage payments after reset on their ARMs are not. Their real mortgage payment rate could actually be 6% or 7%. That is actually why we are having this subprime crisis at the moment to begin with. So if we could switch them back to the more affordable renting only economically for a period of time they will be able to continue to keep legally and stay in their homes and thus avoiding foreclosures.

If the Generic SwapRent (SM) rates start trading higher in the future due to supply and demand, there will always be FVCMs for the homeowners in which they will be able to change the upside vs. downside ratio through AG and DP SwapRent (SM). That will be left to the bankers to figure that out in order to create enough monthly subsidy to let them avoid default/foreclosure. The homeowners do not have to understand how that works internally. Free market competition and regulatory supervision will make sure bankers do not over charge like in any other businesses.

Again, SwapRent (SM) is basically the economically synthetic version of the traditional “sales and lease back” transaction. It only transfers the economic interests while the homeowners continue to own 100% of the legal title of their homes. It allows the homeowners to switch between owning and renting only economically during the contract period while maintaining the entire legal ownership.

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