Mortgage to Lease: Good for Borrowers, Better for Banks
The foreclosure crisis is far from over, and its shadow still looms over a housing market stumbling its way toward recovery. For a small percentage of the estimated 2 million homeowners now mired in the foreclosure process, a pilot program may spell relief. For Bank of America (NYS: BAC) , the pioneer of this new idea, it could become a very lucrative alternative to the standard home-repossession procedure.
An alternative to foreclosure
Bank of America recently announced its new program, called Mortgage to Lease, which will be offered to about 1,000 homeowners in Arizona, Nevada, and New York. The bank will pre-screen the chosen customers before extending an invitation, to make sure they fulfill certain requirements: They must be 60 days behind on mortgage payments, have failed loan modification, and owe more than their home is worth. The practice, known as "deed in lieu of foreclosure," entails the borrower to then hand over the deed to their home to the bank. It was used extensively during the 1930s, but the new wrinkle is that not only will the loan be forgiven, but the lender will also allow the former owners to rent the house at or below market rents for up to three years. Of course, the new tenants will also have to prove that they can afford to do so.
For homeowners, the benefits are many. Besides the obvious advantage of being able to stay in their former house, they will most likely pay less in monthly rent than they were paying in mortgage payments. Their credit rating will take a much softer hit, and they will no longer be responsible for taxes or insurance.
For the bank, it's an even sweeter deal. Instead of losing money on a deteriorating, vacant house, they can make back expenses while the home is occupied. A cared-for home will sell more easily, and B of A states unequivocally that the homes will eventually be sold to investors. The biggest advantage for B of A, however, is the avoidance of the foreclosure process, which can cost up to $78,000 per home. The average amount of time to complete the procedure can be up to two years, during which the bank sees no cash flow from the property.
Other banks may follow suit
If this program works out, other banks may find it beneficial to start their own programs. Other signatories of the "robo-signing" settlement, such as Wells Fargo (NYS: WFC) , JPMorgan Chase (NYS: JPM) , and Citigroup (NYS: C) , also hold a number of soon-to-be-foreclosed homes on their books, and the settlement makes it more attractive for these banks to engage in short-selling, as they will receive credit toward their portion of the settlement amount when they do so. Indeed, the very borrower who Bank of America considers a good candidate for its program is just the type that might be involved in a short sale. So when the bank eventually sells the property to an investor for less than what the homeowner owed, they may be getting -- literally -- more than they bargained for.
An industrywide adoption of such a program by these banks could have a positive effect on their reputations, which have been more than a little blackened by the financial crisis in general and the inappropriate-foreclosure scandal in particular. By keeping more homes out of the foreclosure pipeline, the housing sector may also have some breathing room in which to recover. Fewer homes on the market mean higher prices, particularly when arm's-length sales don't have to compete with distressed, bargain-priced homes. For this, certainly, banks will be given much credit.
Investors can love banks again
Bank of America will obviously be the first to profit from this program, and I think it will profit very well. The cushioning of its bottom line as it turns a formerly expensive business chore into a public relations-enhancing enterprise will make it a better investment than it's been for some time. Of course, not all delinquent borrowers will be good candidates for the program, but if the program helps banks keep more money on their books as well as polish their tarnished images, I'm betting that they may even relax the standards a bit to include more troubled loans.
There is also talk of expanding the program to include investors who agree to purchase distressed properties with the caveat that they retain the former owners as tenants for a certain time frame. What's noteworthy here is that the aforementioned banks named in the settlement get credit against their portion of the settlement even if it is investors who take the loss on a short sale, so this scenario is another win for the banks.
Time will tell whether this will be a workable solution, but I don't think it can miss. As other banks sign on, it might even become fashionable to like big banks again.
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At the time this article was published Fool contributorAmanda Alixowns no shares in the companies mentioned above. The Motley Fool owns shares of JPMorgan Chase, Citigroup, Wells Fargo, and Bank of America. The Fool owns shares of and has a covered strangle position in Wells Fargo.Motley Fool newsletter serviceshave recommended buying shares of Wells Fargo. The Motley Fool has adisclosure policy. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.