Like many other Americans, Victoria and John Coleman have been eyeing the real estate market in San Francisco for a number of years, only to find that as their hard-earned savings grew, so did real estate prices, putting their homeownership dream further and further away. Finally, with the precipitous decline of property prices and historically low interest rates, they are in a position to buy their dream home. Yet, they hesitate as further price declines look almost certain and the Colemans are now afraid that their home purchase is going to put them at a virtually unlimited financial risk. They expect to live in their home for some time, so small real estate price changes are not the concern. The concern is that with foreclosure sales looming the market might drop another 1/3rd or more, not only eliminating their equity but putting their entire financial future and serious risk.
If only the Colemans knew that the U.S. Patent Office is currently reviewing a patent on a financial instrument that can offer them a perfect solution. It's called the True Non-Recourse Mortgage. You might like the "true" in the title, but you might like the ability to sell your house at will for the outstanding loan balance even better. If you're thinking this is a lot like default, it is not. In default you stop making payments on your mortgage, the bank repossesses your home, and a whole bunch of bad things happen to all. You, in particular, would loose your hard-earned credit rating at the very least, but could potentially get your wages garnished. The True Non-Recourse Mortgage, on the other hand, allows you to walk away from your home by exercising a financial contract. The underwriter of the contract returns the loan to the lender on your behalf, and undertakes to sale your house and absorb any further losses. This possibility does not come without cost, as you still lose your equity, but at least your losses are limited and you can start fresh with no further consequences. In other words, you have only a limited downside exposure to the real estate market. If the Colemans could enter such a contract, then their fears of future price declines are to a large extent put to rest.
This is great for the borrower, you think, but who would underwrite such a contract? Which financial institution would absorb the risk of having to buy properties from homeowners all across the country? A financial institution would do it for the same reason financial institutions take on the risk of earthquakes, floods, stock market declines, exchange rate movements, among many others. The financial institution would assess the risk of property prices declining to such an extent that you loose the equity in your home, and establish an insurance premium based on this. In fact, mortgage insurers already are doing this, except the beneficiary is the lender, not the borrower. Something is fundamentally wrong with a model in which the borrower pays for the insurance premiums but the lender benefits. The True Non-Recourse Mortgage fixes this discrepancy. Under the terms of this financial instrument, the homeowner pays the insurance premiums, and the homeowner benefits.
The True Non-Recourse Mortgage benefits go far beyond the borrower and the lender. In fact the entire real estate market benefits from this arrangement. When prices decline the insurance payments represent a cash infusion in the weak market, allowing people to purchase new properties. This arrangement then stimulates demand, and where prevalent would on its own limit the downside for the entire market. Furthermore, at no time the property is deteriorating essentially without an owner. The transaction is quick and smooth, with little of the negative effects of the current foreclosure system.
So watch for the True Non-Recourse Mortgage. Sooner or later a financial institution will realize the benefits of this new type of mortgage contract and will offer it to you. Let's hope this happens fast, as every real estate market could use a little help right about now.
Andrey Pavlov, along with Susan Wachter and Peter Ekstein, is an inventor of the True Non-Recourse Mortgage, which has a patent pending with the U.S. Patent Office.