Let’s look at an example from the Bank's perspective. Assume they originally loaned a $190,000 on a home that was originally worth $230,000. Now they find out that the home is worth $200,000.
Their borrower has an adjustable rate note that has just adjusted up from 8.5% to 10%, so their borrower's P&I payment has just risen from $1,461 to $1,667. The borrower can no longer afford the payment and, with the current market, selling the home before a foreclosure is not an option. With the current financing tools, they are a foreclosure waiting to happen.
That is not the case if they refinance the loan into Term Ownership.
If they refinance into Term Ownership on a five year term, the Borrower's monthly P&I payment drops from $1,667 to $1,008 per month, a nearly 40% drop. Their home is, once again, affordable. Over the course of 5 years, assuming the rate in their note would remain constant, the homeowner would save about $39,500 in payments. The five year figure is based on a term loan amount of $60,000 less a credit for the $10,000 in equity they have remaining in the home that is used to buy down the Term Loan. The interest rate also remained at 10%.
If the Financial Institution is concerned about housing prices in five years, they can easily structure the transaction as a ten year term. The ten year term would be slightly higher for the borrower at $1,143, but still over $500 less per month than the recently adjusted loan payment. The ten year figure is based on a term loan amount of $96,500 less a credit for the $10,000 in equity they have remaining in the home that is used to buy down the Term Loan. The interest rate also remained at 10%.
In those situations where the financial institution already holds the Property in its own portfolio, it should be rather easy for the institution to refinance and act as both the lender and the investor. If not, then the lender may wish to act the part of the investor anyway or look for outside sources willing to fund the investment component.
If the bank forecloses, the loss will likely be around $60,000 (remember there is $10,000 equity in this property the actual loss to the bank would likely only be $50,000 but the sale of the asset would be for approximately $140,000 after all costs are factored in). If instead they receive 10 year's worth of payments at $1,143, it will receive $137,160 in payments and get their share of the housing equity at the end of the term. Assuming the bank only gets $200,000, the total value of the transaction to the financial institution is $337,160. The transaction has become profitable.
In order to achieve a comparable result with the $337,160 at the end of ten years from the $140,000 received at the end of the foreclosure process, the bank would need to garner an Internal Rate of Return (IRR) of 9.187%. But if there is equity shared, a mere $30,000 (Meaning this $200,000 house is worth and $260,000 ten years from now), the IRR would have to be 10.122%.
These are good returns. These are excellent returns. Homeowners who currently have at least some equity in their property should be reviewed for an immediate refinancing transaction into Term Ownership.