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A “No-Cost” Refi Alternative to Principal Reduction

Only time can tell which of the new loan solutions to the housing crisis will eventually succeed, but the search is still on. And at least one option introduced by Carpe Aquam Capital LLC of Marlton, N.J., has already earned the attention of policy makers and bankers alike.

The nonbank has introduced a new mortgage that banks, lenders and other financial guarantors can use to help underwater borrowers reduce their mortgage payments by up to 50% without offering a principal reduction.

Distressed or not, homeowners have an opportunity to access capital to refinance their existing loans into a new mortgage that helps avoid foreclosures and sustains homeownership in the long term. All transactions are conducted by private-market entities and are void of taxpayer subsidies.

The loan structure is based on separating the risk characteristics of a loan into transparent and distinguishable components, says CAC’s president John Burkey, after whom the loan is named only to simplify the registration process.

CAC does not originate Burkey loans directly—allowing banks to maintain their lending and servicing rights while preserving brand identification with mortgage borrowers. Mortgage banks, lenders and servicers can refinance or modify existing mortgage loans in compliance with the BurkeyLoan structure before these loans are acquired by real estate investment trusts. CAC acts as a manager that coordinates all Burkey loan transactions with participating REITs.

Burkey loans can be used to refinance underwater mortgages, home equity lines of credit and second mortgages, or to reduce monthly mortgage payments.

Homeowners interested in lowering their monthly payments, those who want to refinance their adjustable-rate mortgage into a fixed-rate loan, or are underwater can apply for a BurkeyLoan through their bank or other banks and financial institutions that offer it. Since the CAC does not directly originate loans from consumers or nonrisk intermediaries, the homeowner and the lender need to agree to refinance the existing loan into a BurkeyLoan.

CAC manages capital invested in residential mortgages structured following three basic BurkeyLoan funding options that cater to slightly different borrower needs and investor challenges.

The BurkeyLoan Strategic Mortgage Fund offers an incentive for borrowers in good credit standing allowing them to hold negative equity and traditional equity mortgages, including multilien loans. It is an interest-only loan that is not high-risk “because it is based on the core value of the house,” he said, plus the loan is a fully assumable mortgage that does not have a term.

The BurkeyLoan iREO Mortgage Fund helps keep homeowners in homes as renters.

The BurkeyLoan DfX Mortgage Fund is designed for distressed—but not subprime—borrowers seeking lower monthly mortgage payments so they can avoid foreclosure.

“All of the funds offer homeowners the option to participate in shared appreciation type arrangements that further reduce payments.”

For example, depending on the severity of the payment delinquency, the bank will accrue the interest that is not being paid by the customer. Banks can refinance any loan into a BurkeyLoan applying a different interest rate, depending on the risk level.

“We make the argument that payments matter more and than the equity in the house,” Burkey says, and that is a very strong incentive to prevent “strategic defaults,” which are a major risk if the banks were to implement a blanket type of principal reduction modification.

It can be a very effective solution in times when “the downside risk is at a minimum,” because prices truly have reached bottom, he says. So despite of the current severe depreciation, “housing will come back seven, eight, or ten years down the road.”

All the funds will be owned by REITs, which means, “In time the banks will have the ability to sell off whatever risk they choose and in the process also allow the homeowners to share into the risk,” he explained. Initially the banks own all the loans but later on they may decide to sell off the components.

Furthermore, the executive says, the BurkeyLoan combines micro and macro market benefits by helping increase household discretionary income, which as a rule translates into increased consumer spending that fuels economic growth. In addition, it can serve as a risk mitigation tool that facilitates the transfer the government-sponsored mortgage-backed security market to the private sector.

There is one limitation: Burkey loans are available “only to state and federal governments, banks chartered by them and select financial institutions,” such as Fannie Mae, Freddie Mac and FHA loans.

The No. 1 goal is to create access to capital through “a process that is clear and transparent all the way from the homeowner and all the way to the investor.” However, while it is true that most mortgage loans are debt related, most REITs are equity related, he argues. “At the very end” the investment banking firms have the assurance “that there’s different ways to structure those equity shares” when paying REITs the 90% of income dividend. “They can structure those into fixed payments for those institutional buyers that need a fixed income type product.

“From start to finish it’s very transparent. You know you’re buying 50%-55% LTV product. It’s not going to be like a securitization where everything happens in the pool and you’re catching the waterfall, hoping it’s at the fourth to fifth level. This is pretty clear and right upfront.”

The product has already received “a tremendous response from the banks,” he said. It also has been presented to the Senate Banking Committee, and may be included in future legislation.

The reason why it has received such positive feedback, Burkey says, is that this solution offers a significantly more cost-effective alternative to principal reduction.