Tell me why it won't work

[Bill Hennessy]

I need 100 people to tell me this won't work, doesn't have a chance, is doomed to failure. I also need just one to say, "Just maybe . . ."

Guess who I'll listen to?

Seriously, though, there are a thousand problems with my idea that I can think of. There must be a thousand more. The skeptics will only make us stronger, so help the cause by warning us of the pitfalls.

Oh, and ways to mitigate those problems would be appreciated :)

[Annoyed]

I won't tell you it won't work, you'll get plenty of that I'm sure. What I would like to see is how it is structured. On your blog you mention this being a non-profit group, which is OK, but what about the donations? Are people giving to charity or are they making an investment and expecting a return. Charity is nice but an investment situation will get you more people signed up to give. I'm no expert but I would think that with this being a non-profit it would get even more people to sign up as investors since more of the return (i.e. profits) will go back to them and not to the organization. The organization becomes the facilitator and the people giving become the profitors. A win-win in my book.

What I think would take the most work, and generate the most arguments, is what will the criteria for granting a loan be? Personally I'm not too keen on duplicating what has happened in the markets today, but giving to those that can't afford the loan in the first place. However I am for giving to those that show they can repay the loan but just don't have that traditional 20% down payment. Most first time home buyers would fit into this category. I happened to be one of those that had to %100 finance. I can afford it, but I just didn't have that huge lump down payment sitting in the bank.

You may not use quite as strict credit standards as a traditional mortgage broker or bank, but some standards should be in place to protect those that are giving their money as loans. Show the ability and recent history of making payments on their current stuff, etc.

As for dispersing the money, I personally wouldn't sign up if it meant my money went directly to a user that I chose. Instead I would rather give a few hundred or whatever and have that spread out and get a return on that lump sum. Sure I could do this manually but that would be tedious, although I suppose the option would be nice to go either way. Think of it like a mutual fund. You put your money in each month and the fund diversifies that amongst it many stocks and bonds. This could operate in much the same way, with homes being the collateral and mortgages being the investment instrument.

As an investor I would also want to make sure that the requesting family actually proved they were trying to buy a home and not just end up getting a personal loan on my good faith. Call my cynical, but people would try to game the system somehow; it is just inevitable. Downside: if you make it an investment I suppose one could argue that you become a REIT or something like that and would have to follow regulations and what not. Who knows.

The "charity" approach might be easier to administer, but I feel you would get far less involvement. Given the amount of money people would need it would also burden the recipient with trying to pay back 10's or 100's of people.

Or am I totally off base here??

[Bill Hennessy]

Annoyed,

Thanks, so much, for dropping in. I'll have time only for quick answers--I'll post more detailed ideas tonight.

First, I see that as an investment opportunity for lenders. My high level idea is to pay make annuity payments to lenders from the payments received for the homes they've funded proportional to the lender's contribution. For simplicity, say a single lender funded a single buyer for $100,000 home at 6.5% on a 30 year loan. Assuming the loan current, the buyer would make normal mortgage payments of $632.07 a month. The Lender would receive an annuity payment on the anniversary in the amount of $7,584.84 for 30 years.

I am hoping that the full $100,000 loan would be tax deductible in the year the loan was funded. When annuities are withdrawn, I assume that the principal would be taxable as income (deferred from the year of investment) and interest would a capital gain. We may need to do some lobbying to make the loan deductible until withdrawn, but that's part of our challenge.

The organization would operate as a non-profit or as a charity, depending on the legal advice we get.

Interest earned from the montly mortgage payments from reciept to annuity payment would fund the operating expenses of the organization and pay any salaries required--though I hope most of the work would be voluntary.

I do expect a down payment requirement, but I'm not sure that 20 percent is necessary. That amount may encourage borrowers to borrower the down payment at onerous rates, increasing the risk of the primary note. That was a problem in 1990s, before banks loosened up the money down requirement. At 8 percent, lenders are well protected against property value declines over the life of the mortgage, though there is risk of volitility in the short term.

I think the organization would insist on documentation of the home. I see a two-phased approach: first, the borrower requests pre-approval to establish eligibility for loan up to some amount. Second, final approval is based on the traditional appraisals, etc., of the proposed property.

Again, I'll provide more details of my business model later. Hope this clarifies some of your questions. And thanks, again, for helping out.

[Bill Hennessy]

In my previous reply I forgot this important point:

On whether lenders chose their borrowers or not, I see room for options. One big lender could fund 100 percent of one borrower's request. Or 1,000 small lenders could fund one borrower. I'd really like to create a connection between the lender and borrower, but if that model doesn't work, I can let go of it. (This isn't "my" organization, really--it's a community project.) I like the idea that the lender and the community can, if the borrower chooses to provide updates, stay abreast of the impact they've had on human lives.

If, however, lenders want to simply contribute an investment and take the return from a pool, I think we can make that work.

Thanks, again.

Annoyed said:

I won't tell you it won't work, you'll get plenty of that I'm sure. What I would like to see is how it is structured. On your blog you mention this being a non-profit group, which is OK, but what about the donations? Are people giving to charity or are they making an investment and expecting a return. Charity is nice but an investment situation will get you more people signed up to give. I'm no expert but I would think that with this being a non-profit it would get even more people to sign up as investors since more of the return (i.e. profits) will go back to them and not to the organization. The organization becomes the facilitator and the people giving become the profitors. A win-win in my book.

What I think would take the most work, and generate the most arguments, is what will the criteria for granting a loan be? Personally I'm not too keen on duplicating what has happened in the markets today, but giving to those that can't afford the loan in the first place. However I am for giving to those that show they can repay the loan but just don't have that traditional 20% down payment. Most first time home buyers would fit into this category. I happened to be one of those that had to %100 finance. I can afford it, but I just didn't have that huge lump down payment sitting in the bank.

You may not use quite as strict credit standards as a traditional mortgage broker or bank, but some standards should be in place to protect those that are giving their money as loans. Show the ability and recent history of making payments on their current stuff, etc.

As for dispersing the money, I personally wouldn't sign up if it meant my money went directly to a user that I chose. Instead I would rather give a few hundred or whatever and have that spread out and get a return on that lump sum. Sure I could do this manually but that would be tedious, although I suppose the option would be nice to go either way. Think of it like a mutual fund. You put your money in each month and the fund diversifies that amongst it many stocks and bonds. This could operate in much the same way, with homes being the collateral and mortgages being the investment instrument.

As an investor I would also want to make sure that the requesting family actually proved they were trying to buy a home and not just end up getting a personal loan on my good faith. Call my cynical, but people would try to game the system somehow; it is just inevitable. Downside: if you make it an investment I suppose one could argue that you become a REIT or something like that and would have to follow regulations and what not. Who knows.

The "charity" approach might be easier to administer, but I feel you would get far less involvement. Given the amount of money people would need it would also burden the recipient with trying to pay back 10's or 100's of people.

Or am I totally off base here??

[Annoyed]

You're thinking much bigger than I had thought. For some reason I was only thinking about funding the down payment portion of a loan, but you're aiming for the whole mortgage. Very interesting. So in the simplest terms the company becomes a broker for mortgages and the funding for the brokerage comes from private individuals. That might open up a whole can of legal worms, but hey that is where those volunteer lawyers come in!

The annuity approach is interesting. I haven't done too much reading on annuities, but what I have read suggested other options would be better. However those could have just been in the context of what I wanted, not in general. For example some insurance programs offer annuities and such and there are better options in some cases. This may be completely different though.

There are certainly details to consider, but large and small. Such as what happens during a default, who owns the property? What if an investor wants to sell their mortgage and cash out? I suppose eventually you could set up a system within the organization to handle lender to lender transactions. Just don't package them up and resell them to big mortgage houses, like say, oh, Fannie Mae :)

In any case, the devil may be in the details, but the idea sure seems sound. I look forward to reading more of your thoughts on this.

[Bill Hennessy]

Thank you. I agree that insurance annuities are usually weak as investment goes, and that's only one option. Because we're not trying to maximize value of the organization, like a bank, we might be able to give lenders more options. I like the annuity because the interest could fund the overhead of the organization so that 100 percent of a loan goes to the borrower.

I look at it like this: 1,000 people lending $100 could put a family into a $100,000 home. Or Franklin Raines could invest half of the $90,000,000 he made at Fannie Mae in 6 years and put 450 families into $100,000 homes. (Raines's annuity would be $3,413,178 a year for 30 years, BTW.)

I don't know why lenders couldn't sell their notes to others--in fact, the web site might also offer a lender-to-lender connection to accomplish such transactions. This, I assume, would work something like a bond sale.

I was hoping to get more work done on this tonight, but I have a sick child who needs some attention. I'll be adding more detailed possibilities as time goes. In the meantime, please don't hesitate to throw more ideas around. The answer's out there, I'm sure.

thanks,
Bill

Annoyed said:

You're thinking much bigger than I had thought. For some reason I was only thinking about funding the down payment portion of a loan, but you're aiming for the whole mortgage. Very interesting. So in the simplest terms the company becomes a broker for mortgages and the funding for the brokerage comes from private individuals. That might open up a whole can of legal worms, but hey that is where those volunteer lawyers come in!

The annuity approach is interesting. I haven't done too much reading on annuities, but what I have read suggested other options would be better. However those could have just been in the context of what I wanted, not in general. For example some insurance programs offer annuities and such and there are better options in some cases. This may be completely different though.

There are certainly details to consider, but large and small. Such as what happens during a default, who owns the property? What if an investor wants to sell their mortgage and cash out? I suppose eventually you could set up a system within the organization to handle lender to lender transactions. Just don't package them up and resell them to big mortgage houses, like say, oh, Fannie Mae :)

In any case, the devil may be in the details, but the idea sure seems sound. I look forward to reading more of your thoughts on this.