NEW YORK (MainStreet) — When Indonesia-native Zackaria Margolang bought a Newark, N.J. house in May 2008 for $435,000, his 30-year fixed-rate mortgage through Countrywide Financial was 5.5% with a monthly payment of $3,200, including taxes and insurance. A bona fide homeowner at 40, the Hilton Hotel prep-cook was living the American dream.
Or so he thought.
Even though he settled comfortably into the three-bedroom, two-bath townhouse, come early 2011 while going through a divorce and supporting his young son, he struggled to keep up with his mortgage, which Bank of America had since taken over. He went into foreclosure, ultimately facing a $466,000 tab with the mounting expense of mortgage loans, mortgage insurance, taxes and foreclosure fees. Though he found his financial challenges insurmountable, he amazingly didn't lose his home.
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That's because New Jersey Community Capital (NJCC) came up with a solution to help distressed homeowners by using private investment to provide mortgage principal reduction, homeowner counseling and vacant property rehabilitation. What kept Margolang from falling off the ledge could offer policymakers a suggestion on how to lessen the blows of a foreclosure crisis. And it's a win for banks along with the homeowners, to boot.
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Despite the fact that 2012 saw big banks – Ally Financial (ALLY), Bank of America (BAC), Citigroup (C) and Wells Fargo (WFC) – agree to the National Mortgage Settlement
, for which they paid out a $25 billion sum to resolve problems related to the 2008 housing bust as settled by 49 state attorneys general, many borrowers are still in dire straits. In the pipeline are billions more in settlements – with recent reports indicating that Goldman Sachs (GS) is exploring a settlement with the Federal Housing Finance Agency (FHFA) for up to $1.25 billion. But the settlement funds don't always make it to distressed individuals or even to state housing initiatives.
That's where NJCC can serve a vital role in bridging the gap.
How the Public-Private Mechanism Works
NJCC's ReStart Home Preservation Program aims to increase the likelihood that homeowners will succeed in their mortgage payments. NJCC, a 25-year-old community development financial institution certified by the U.S. Treasury, participated in the Federal Housing Administration's Distressed Asset Stabilization Program (DASP) in the fall of 2012 to buy nonperforming FHA mortgages from the Department of Housing and Urban Development (HUD) on hundreds of properties in New Jersey and Florida.
As in Margolang's case, the mortgages in the pool NJCC purchased were typically delinquent for two to three years, and the properties were severely underwater; in Margolang's Essex County, N.J., for instance, the $318,000 owed in average principal well exceeded the $175,000 average value of a home. With the mortgages being offered at a fire sale, NJCC was able to capitalize on the bargain to benefit distressed homeowners: NJCC got each mortgage for 50 cents on the dollar of a home's market value and restructured the tax in a high-touch program. NJCC underwrote each mortgage and determined if a particular homeowner met the underwriting guidelines for the modifications. In turn, NJCC sent the loan modification term sheet to the servicer. Then NJCC worked with a local non-profit to make contact with homeowners to develop a loan resolution plan and modify the mortgage through principal reduction.
In the case of Margolang, NJCC assigned Newark-based La Casa de Don Pedro to help counsel him. The community-based development corporation, which provides comprehensive services such as employment and housing advice, reached out to Margolang in September 2013 and explained the unique opportunity he faced because his mortgage was included in the pool NJCC purchased.
"My house is my secure home to live in," Margolang told MainStreet
. "If I end up living in this country for good, I have to build something solid about my living place."
The market value of the house was around $180,000, so to free Margolang of his obligations to the greatly inflated principal of $466,000, NJCC worked out a debt reduction of $238,000 and an additional forgiveness of $48,000. Essentially, what Margolang owned on the mortgage equaled the value of the house.
"The house was so far underwater, and we put the water mark right where the house is," said Alle Ries, director of community and economic development at La Casa de Don Pedro.
There are certain checks in place to make sure the situation is sustainable for homeowners. For example, the mortgage payment can't be more than 35% of household income. As a result, Margolang's monthly payment dropped 50%, from $3,200 to around $1,600.
Because his mortgage was now considered a high-risk loan, Margolang saw his mortgage interest rate hoisted to 7.375% by investors. Yet the reduced monthly payment and structured long-term strategy to pay off his mortgage greatly increase his prospects for staying in the home.
There's a trial modification period of three months to ensure the homeowner can make the payments. After that period, the mortgage is permanently modified, and the homeowner has regular counseling sessions for the next six months. If a resident does not want to stay in a home, NJCC gives the person transitional assistance and preserves the person's credit instead of having him go through a full foreclosure.
Beyond saving homeowners struggling with foreclosure, this program is recognized by federal and state lawmakers as a key strategy for rebuilding efforts post-disaster. NJCC has used this public-private model for disaster recovery in the wake of Superstorm Sandy with its "ReStart the Shore" initiative. NJCC has leveraged over $80 million in private investment to purchase more than 500 nonperforming FHA mortgages from HUD that total over $138 million in unpaid principal balance in the nine counties more severely affected by Sandy. The transaction, which closed November 2013, is the first such direct bulk sale that HUD has ever made.
ROI for Doing Good
NJCC's initiative represents an innovative national model of how best to respond to the needs of low- and moderate-income communities impacted by financial challenges. In this equation, NJCC essentially serves as an intermediary to pair socially-minded investors with urban neighborhoods and individuals that are divested of capital. This is in places like Camden, N.J. or Margolang's Newark.
The subprime mortgage crisis, which metastasized in the Great Recession of 2008 and its aftermath, seemed certain to claim Margolang as a victim. This initiative mitigated the damage.
"When houses become vacant, it drains the life out of the neighborhood," said Wayne Meyer, NJCC's president. "That's from a human and a financial perspective."
Meyer said NJCC had the goal to soften the impact of the housing pain points and increase opportunity in the community.
"When a house comes at foreclosure, it also depresses surrounding values," Meyer said.
By aggregating capital, Meyer is also able to get a new market tax credit to promote commercial development. NJCC was able to achieve discounts to develop more properties on a meaningful scale. This credit promotes economic development and provides venues where residents can work.
Companies and individuals are able to allocate capital to this initiative to stabilize housing problems and also make a reliable return on investment. One such investor is Prudential, which enthusiastically participated in the ReStart program.
"Because Prudential is based in Newark, we have seen firsthand the devastating impact of foreclosures not just on the impacted families but also on the surrounding communities," said Lata Reddy, vice president of corporate social responsibility at Prudential. "ReStart struck us an innovative mechanism for keeping families in their homes in lieu of foreclosure, and we were confident that NJCC would be a responsible steward of those properties for which modifications could not occur."
This stewardship is essential since many other traditional for-profit players operating in this space may have a short horizon, aggressive practices and limited regard for the surrounding community.
Prudential invested more than $7.3 million in support of ReStart's efforts in New Jersey and Florida, which continue to suffer from the highest foreclosure rates in the country. The investments Prudential has made have the potential to impact 746 families, 70% of which are located in the New Jersey counties most affected by Superstorm Sandy.
But it's not just beneficial from an altruistic standpoint; this is also a smart money move from an investment perspective.
"Besides significant social benefits, we think ReStart's model will also outperform from a financial perspective since it is far quicker to implement than conventional foreclosures, avoids the delays associated with marketing and leasing units, and preserves families with strongest incentives to stay and invest in the neighborhood," Reddy said. "We also think having a geographically concentrated pool creates better economies of scale and encourages a greater emphasis on overall community."
The return for those who invest capital in the program could be 8% to 10%, Meyer said.
"Think of this as a new model for jump-starting housing problems," Meyer said. "If we can buy these [struggling mortgages] and work with the borrowers to keep them in their homes, we're helping the communities in a new way."
Banking on the Advantage
The maneuver NJCC employs is also a boon for banks.
"I believe it would be beneficial for a bank to sell their distressed assets to a program like ReStart," said Jennifer Murphy, director of housing programs at NJCC. "They can remove the nonperforming asset from their books while allowing us to provide their borrowers with affordable home retention options."
Plus, foreclosure is anathema to banks. In this public-private investment, banks recover more money by selling the mortgage to NJCC than they would by foreclosing on a home and selling it at auction.
"Clearly it's a win-win," said Stijn Van Nieuwerburgh, professor of finance and director of the Center for Real Estate Finance Research at NYU's Stern School of Business. "Banks are able to reduce their non-performing loans and improve their own financial health and that of the financial system more broadly in the process."
It's that very connection between the individual and the surrounding economy that is the lifeblood of the program.
"Keeping homeowners in their houses, especially if they have been duped by shoddy mortgage practices, strikes me as a laudable goal," Van Nieuwerburgh said. "There is now a better understanding that foreclosure has the potential to disrupt not only the life of the family involved, but also negatively affect the neighborhood in which the foreclosed home is located. To the extent that such negative externalities are avoided, this activity is beneficial."
The Challenges Ahead
Still, the housing outlook is far from cheery. There are 9.8 million households still underwater – where homeowners owe more on their mortgages than their house is worth.
Even though RealtyTrac Inc. reports foreclosure starts numbered 747,728 in 2013, down 33% from the previous year – with mortgage delinquencies less common amid steady job growth and rising home prices – the environment has limited improvement.
NJCC offers a compelling proposition: rather than having financial institutions enter into modification, sell the mortgage and take the loss, they pass it onto a homeowner who has financial support and guidance. Another CDFI doing similar work in taking private investments to offer new mortgages is Boston Community Capital, but that organization doesn't use the bulk-purchase approach NJCC does.
Financial institutions may be loath to enter the fray, wary of moral hazard, where they'd be more willing to take risks because the consequences will be borne by the homeowners. But from Meyer's perspective, DASP from HUD Secretary Shaun Donovan is a comparable community stabilization pool. Thus, Meyer sees the public-private workings of a community development financial institution like his NJCC as an essential stepping-stone in the path to salvation.
"Programs like NJCC and other non-profits looking to purchase notes at a discount and rework them, they're doing a great job to come up with a new tool, a creative and innovative tool," said Kirsten E. Keefe, senior staff attorney at the Empire Justice Center, a New York state public interest law firm focused on poor and low-income families. "The details are very complicated. But they're helping home-owners stay in their homes."
That said, Keefe views the system as inherently broken. The FHFA has prevented servicers from making mortgage principal reduction themselves.
"There has been such a reluctance if not obstinance against doing principal reduction," she said. "It's a little bit crazy that the policies we have in place have compelled the buying of these assets at a discount [as in NJCC's program]. It's a tool that has been developed, because servicers have been refusing to do principal reduction directly. It's very inefficient."
But such is the system, and Meyer and the NJCC team are currently looking to acquire another pool of FHA mortgages. They were recently outbid in Cumberland County, New Jersey – facing a tab upwards of 64 cents on the dollar for a batch of nonperforming mortgages.
NJCC is eager to acquire more non-performing mortgages, because New Jersey, in particular, could use extra help. Though the state received $75 million for housing counseling from the attorneys general settlement, Gov. Chris Christie used those funds in the general budget. Christie also got rid of the foreclosure mediation plan, even though the state ranks number one in foreclosures.
But as the foreclosure crisis lingers, this innovative technique seems a promising element in righting the ship.
"It's not the only solution, but it's an important part of the puzzle," Meyer said.
--Written by Ross Kenneth Urken for MainStreet