Wealthy Borrowers Sacrifice Upside for Down Payment AidJody Shenn and Heather Perlberg
Jeff Uter would have needed to sell stocks or pull cash out of his consulting business to afford the down payment on a $780,000 home in Orange County, California.
Instead, he paid half of the 20 percent required and got the other $78,000 from San Francisco-based FirstRex. In exchange, the real estate investment firm will get 40 percent of any gains in the value of Uter’s 4-bedroom condo in a golf course community.
“I have stocks and my own business,” said Uter. “I’d rather invest in that than put it in a personal residence.”
FirstRex is seeking to benefit from homebuyers who need extra cash as values climb at about the fastest pace since 2006 and lenders require larger down payments after loose mortgage underwriting helped fuel a global crisis. It’s luring banks in expensive markets from California to Connecticut that must compete harder for customers after a surge in borrowing costs from near-record lows dried up refinancing demand.
With the recovery underway, FirstRex started offering the down payment assistance this year using money from pension funds and endowments to fill a need otherwise served by wealthy relatives, according to co-Chief Executive Officer Jim Riccitelli.
“Houses are really affordable right now because interest rates are low, even after the recent run-up, but housing is not that accessible,” Riccitelli said. “If you can’t get the house, affordability doesn’t really matter.”
While almost half of all renters who’d like to buy are concerned about down payments, FirstRex’s initial focus is on high-end markets within California, Washington and Oregon, where its customers’ average house price is $800,000. The company also plans to invest in Massachusetts and Connecticut homes, according to Riccitelli.
For lower-cost properties, the Federal Housing Administration insures mortgages as large as $729,750 and allows down payments as low as 3.5 percent. FirstRex’s offering also isn’t approved for loans of less than $625,500 bought by government-backed Fannie Mae or Freddie Mac, which unlike most banks accept private mortgage insurance.
Barclays Plc analysts led by Nicholas Strand wrote in a report last month that the regulator for Fannie Mae and Freddie Mac had looked into the FirstRex. Callie Dosberg, a spokeswoman for Washington-based Fannie Mae, and Brad German, a spokesman for McLean, Virginia-based Freddie Mac, declined to comment, as did Denise Dunckel, a spokeswoman for the Federal Housing Finance Agency.
Banc of California Inc.’s PacTrust Bank and HomeStreet Inc.’s bank are among lenders accepting borrowers with FirstRex participation.
The customers can have very good credit and “typically have very good cash flow,” said Jeff Seabold, managing director of residential lending at Irvine, California-based PacTrust, which has started selling some of the FirstRex-tied loans it makes to other regional banks. Even for those borrowers, jumbo mortgages often require 25 percent or more for down payments, resulting in particularly steep amounts in cities such as San Francisco or Los Angeles, he said.
HomeStreet and PacTrust both allow the shared down payment for loans of any size that can qualify to be held in their portfolios. Both like the fact that an additional party has an interest in avoiding foreclosures, their executives said.
FirstRex said First Republic Bank, the San Francisco-based lender that specializes in wealthy customers, also is a partner. RPM Mortgage Inc. plans to sell its FirstRex-linked loans to an unnamed bank. RPM CEO Rob Hirt predicts 5 percent to 10 percent of its borrowers “will seriously take a look at this program.”
Borrowers also benefit because the equity investment lowers monthly payments by shrinking their debt or helping them avoid mortgage insurance, Hirt said. That may become even more important to lenders with the industry facing new government rules next year, which will expose them to greater legal risk when consumers’ borrowing costs exceed 43 percent of their incomes, he said.
Housing prices across the U.S. soared 12.1 percent in June from a year earlier, according to an S&P/Case-Shiller index of property values in 20 metropolitan areas, though they remain 23 percent below their 2006 peak values. The median price of existing homes sold in July was $213,500, so a 20 percent down payment would total $42,700, according to the National Association of Realtors.
It takes more cash in expensive markets such as San Francisco, where the median sales price from June to August was $850,000, or New York, where it was $1.1 million, according to real-estate website Trulia Inc.
In the past, non-profit organizations such as Nehemiah Corp. of America and AmeriDream Inc. were a common source of down payment assistance for low-income home buyers. In 2008, the FHA banned aid from nonprofits funded by home sellers such as builders, after the assistance accounted for more than 20 percent of its loans in the previous three years, according to a regulatory report. Loans tied to the aid soured faster than others. FHA, Fannie Mae and Freddie Mac still allow gifts from parties that don’t stand to benefit from inflated prices.
Even if the product wins government approval, it probably will stay within the jumbo community in large metropolitan areas, said Steven Delaney, an analyst in Atlanta at JMP Securities LLC.
“You wouldn’t need it for lower-priced homes where you can get in for a less than a 20 to 25 percent down payment,” Delaney said. “I don’t see this being used on $200,000 to $300,000 homes.”
Debt known as shared-appreciation mortgages were available in the U.S. starting in the 1970s, according to a 2007 paper for the Fannie Mae Foundation by researchers including New York University professor Andrew Caplin. Such loans can cause problems for investors because evidence suggests “the incentive to use these mortgages is highest among those expecting no price appreciation and those intent on holding the loans for as long as possible.” The programs are also available in other countries, such as the U.K. and Australia.
Homeowners can get a maximum of half of their down payment from FirstRex, though they also may choose to give up less of an ownership stake, and have the option to buy equity back before selling in up to 30 years. It also shares in any losses.
FirstRex, founded by Thomas Sponholtz in 2004, previously offered a way for existing homeowners to tap their equity without taking on new debt by selling a stake in their homes. After property values collapsed in 2008, the firm shut the program down.
Sponholtz, who worked at Barclays Global Investors before it was acquired by BlackRock Inc., including as co-head of active fixed income, declined to specify how much FirstRex has to invest.
“We have committed fund capital sufficient to invest in excess of a thousand transactions, and a substantial pipeline beyond,” he said.
In the wake of the housing crash, private-equity firms, hedge funds and real estate investment trusts have bought more than 100,000 houses to build rental businesses, transforming an industry dominated by mom-and-pop owners.
Compared with outright purchases of homes to rent by fund managers such as Blackstone Group LP, the world’s largest private-equity firm, the “operating costs are very, very low because the homeowner is really the property manager,” Sponholtz said.
The U.S. homeownership rate fell to 65 percent this year, its lowest level since 1995, according to Census Bureau data, as fewer people were able to qualify for a mortgage. About 47 percent of renters hoping to become homeowners say saving enough for a down payment is a major barrier, according to a 2012 survey by Harris Interactive for Trulia. A total of 12 percent who plan to buy someday would consider borrowing money from friends or family for a 20 percent down payment to get a “dream home,” a June survey for the firm found.
The benefit for home buyers extends past those without enough funds to those wanting to diversify, according to Sponholtz.
“For a young person it could easily be 80 to 100 percent of their net worth tied up in a single asset,” he said.
Uter, who bought his California home in March, said he had enough money for a down payment after selling his previous property. By giving up some home equity now, he said he can later tap other investments that he expects to return more in retirement.
“We’re going to stay for a while,” he said.
Clients could include young doctors or lawyers who “have the potential to make a lot of money down the road but they may want to buy the large home now, to get access to schools or other reasons,” said Rich Walton, a senior vice president at RPM.
While there are mortgage insurers that would take on the risk, none of the banks that buy jumbo loans from Alamo, California-based RPM accept their backing, he said.
Weekly applications to refinance mortgages slumped 71 percent from a 2013 high as the average rate offered on a typical 30-year mortgage rose to 4.93 percent in the week ended Sept. 6, from a record low 3.57 percent in December, according to Mortgage Bankers Association data. Home-loan applications for purchases have declined 14 percent since the start of May when interest rates surged. For 30-year jumbos, borrowing costs have risen to 4.75 percent from this year’s low of 3.87 percent in May, Bankrate.com data show.
With rates rising it’s an especially good time for lenders to embrace a new idea, according to Rich Bennion, an executive vice president at HomeStreet Bank.
“With the sharp drop-off in volumes because of refinancing slowing to almost a stop over the last two or three months, it becomes all the more important to do everything we can to drum up more business,” Bennion said.
Sponholtz and Riccitelli see their timing as fortuitous.
“We might be the only ones active in the market for the next six months or year but we’re pretty sure we’re going to get formidable competition,” said co-CEO Sponholtz.