Monthly Archives: July 2007

07/12/2007 FAQ #8: Could you run a numerical example on how a defaulting ARM borrower whose rate has been reset higher in either the subprime, Alt A or prime sectors could be rescued from being foreclosed?

Maybe the best way is to follow through the examples on the presentation slides #2, #5 and #7. So let’s say a lending bank has a defaulting ARM borrower. If the bank offers him a 5-year SwapRent (SM) to give him $2,000 monthly subsidy for his $800,000 house so that he would not have to default and be foreclosed now. The bank gets to postpone the costly foreclosure to begin with and therefore we could avoid a whole real estate market collapse for now. However, the value the SwapRent (SM) contract provides is more than just postponing. Chances are the homeowners will never have to default irrespective of what happens in the future. So 5 years later, there could be three scenarios, (a) the property stays at $800,000, (b) the property values goes down, say to $600,000, and (c) the property goes up in value , say to $1,000,000.

Under scenario (a), the homeowners simply pocketed all the monthly subsidy for the 5-year period. Nothing needs to be done now and the contact expired. He can sit tight or renew another contract at his will. Under scenario (b), the investor will have to cut a check of $200,000 to pay to the homeowners through the bank. The HELM contract requires that money be used to bring down the original mortgage borrowing amount of $400,000 down to $200,000 (in reality more like $170,000 considering principal pay-down during the 5 year period). So even if the interest levels will be high at that time his mortgage payments will be low since the principal amount has dropped down to $170,000 instead of the $400,000 beginning amount. He can therefore avoid the default even if he decides to do nothing next. Under scenario (c), the property value increased to $1,000,000 as determined by the neighborhood or city property price index. That means we will have a bull real estate market. Most likely there would have been a low interest rate environment right before the SwapRent (SM) contract expired so that the real estate market was pushed higher by this low interest rate environment. So even with a higher principal amount now ($570,000) chances are that the homeowners will be able to lock in a long term fixed interest rate which is affordable to him now and therefore avoiding default. He does own a house that is worth $1,000,000 now so there is no real economic loss to him and his job is more secure since the economy is strong due to this bull real estate market.

Even under an extreme unlikely 4th scenario that the property prices are sky high with a sky high interest rates (a hyper inflation situation where the capitalism system basically is on the verge of failing), the homeowners can still renew another long term SwapRent (SM) to get enough subsidy so that he can stay in the house until he dies or he decides to sell the house in the future. If the Generic SwapRent (SM) rates at that time does not generate enough subsidy, 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) so they he could generate enough up-front subsidy. This leveraging economic concept will be getting closer to what the current market demand for the reverse mortgage products is now, although one is interest rate based and the other is property value based. With reverse mortgages the homeowners will definitely lose their house at the end of the contract but with leveraged SwapRent (SM) contract they may still own it in whole at the end of the contract.

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