PartnerOwn’s work to improve mortgage finance is based on the research of economists Amir Sufi and Atif Mian, who propose the Shared Responsibility Mortgage (SRM) in their new book, House of Debt. Their research into the Great Recession has made them the experts on its underlying causes, and their down-to-earth approach makes their book (and blog) a great read. With this post, we want to introduce a few key concepts that draw on their work and explain the basic need for their proposal, the SRM.
Buying a home is more than buying rooms, a roof, a garage and a backyard. It is buying into a neighborhood, a school district, and a commute to work. A homeowner may control the house but not the neighborhood, the local businesses, or the school district. Things change. And these changes can hurt or help the value of the home. If a nearby employer leaves the neighborhood for example, the home and its neighborhood may be less desirable since there are fewer jobs.
In addition to neighborhood risk, homeowners face market risk. To buy homes, people use a lot of debt (90% of the value of the home for the typical buyer). This is dependent on someone or some institution being able to make those loans. So, starting in 2007, when the housing market began to go through a major correction and banks needed to be bailed out by the government, lending became less common which hurt home values. People who were using the value of their home to get by started to consume less because they lost wealth. This in turn hurt businesses and caused layoffs. More people defaulted on their debt. And overall, nationwide home values dropped over 30% in the course of a single year.
Because most homeowners use debt to purchase their homes, they are not protected if the neighborhood or the housing market changes. The debt is constant. These risks would make any investor cringe, especially since most mortgages are thirty years in length, ample time for the risk to be realized. However, as mortgages have grown in length and require lower down payments, our government and banks still encourage borrowers to take on this greater risk and hope things work out.
This is why PartnerOwn is working to implement Sufi and Mian’s SRM. Its most fundamental innovation is to tie the homeowner’s debt to the local housing market. If home prices go down because of the neighborhood and market risk, the homeowner’s monthly payment will go down as well. So, if the neighborhood decreases by 10% in value, a homeowner’s monthly payments will also decrease by 10%. Effectively, the risk is shared with the lender, who can better handle the risk through modern diversification strategies. This will protect the homeowner who has a significant portion of her wealth tied up in her home and provide relief in case the local neighborhood or housing market experiences a downturn. Additionally, the homeowner never has to make up those decreased payments. It is simply part of the original agreement between the homeowner and the lender.
To pay for this protection, the homeowner would pay a small portion of the increase in the home’s value at sale. So, if a homeowner bought a home for $100,000 and sold it for $110,000, the homeowner would pay 5% of the $10,000 made, which is $500. The homeowner essentially borrows from the future increase in the home’s value to receive protection. If the home does not increase in value, no payment is made. Sufi and Mian argue that this simple innovation would have helped limit the severity of the most recent crisis.
PartnerOwn is currently working to implement a version of Sufi and Mian’s SRM. We have identified a first investor, a local housing agency in Chicago, to help us originate SRMs for its clients. They believe the SRM to be a more responsible form of lending for their clients and a way to invest in their local neighborhood. We look forward to keeping you updated about our progress. And if you have any questions about the SRM, please do not hesitate to contact us along the way.