Are standard mortgages outdated? Dangerous? To blame for the financial crisis?
Atif Mian and Amir Sufi, two economists and authors of the new book House of Debt: How They (and You) Caused the Great Recession, and How We Can Prevent it From Happening Again, certainly think so.
As stated in the Bloomberg article Sharing The Pain, economic disasters are almost always preceded by a large increase in household debt. Therefore, changing the terms of debt contracts to make them more flexible is necessary to prevent the next disaster. Mian and Sufi claim that, had this been done earlier, the Great Recession in the United States would not have been “Great” at all.
Their strategy? The shared-responsibility mortgage (SRM).
This redesign of the standard 30-year mortgage involves lenders sharing the burden if housing prices fall and taking some of the reward if they rise.
The idea is to shelter homeowners, who have significant portions of their wealth tied up in their homes, from housing market risk. When homeowners use debt to finance their homes, they are not protected if a nearby employer leaves the neighborhood or the local school district closes, for example. The debt is constant. Over a 30 year mortgage, there is a lot of time to incur these risks and currently, borrowers are being encouraged to take it all on themselves.
With the SRM, the homeowner’s debt is actually tied to the local housing market. If neighborhood and market risk drive home prices down, say 10%, the homeowner’s monthly payment will go down 10% as well. The risk is shared with the lender who is in a better place to handle the risk through diversifying. The homeowner does not have to make up the decreased payments and the mortgage would still be paid off in 30 years.
Lenders should be willing to forgo a higher rate if the homeowner pays a portion, say 5%, of the increased value of the home when it is sold or refinanced.
As a result of the Great Recession, 4.9 million foreclosures have been completed since the financial crisis began in September 2008 according to the Corelogic National Foreclosure Report. Mian and Sufi say that the SRM would mostly end these foreclosures, which would prevent decreases in property values and benefit entire neighborhoods.
The two economists are determined to make shared-responsibility mortgages a reality. They have launched a startup called PartnerOwn, which is in the process of launching the first SRM with a local housing agency on the Northwest side of Chicago.
Are shared-responsibility mortgages the future of home financing? What do you think?
