A private sector solution to he impending mortgage crisis.

1. “Downsizing in Place”
Home Equity Fraction Interest (HEFI©)
The fundamental mortgage problem is that many homeowners have too much house/mortgage in the
current economic environment – for whatever reasons. If the house were a divisible asset – like a
corporation – the distressed homeowner could sell part of it: downsize-in-place to a sustainable
ownership level. Such a solution is already available in private transactions among family members, and
among universities and their professors. How could downsizing-in-place work? Mortgage holders will
work with homeowners to determine how much mortgage the homeowner can sustain. A new mortgage
at market rates would be written (wrapping all junior claims). In return, the homeowner would grant the
mortgage holder a fractional equity interest in the house. The fractional interest would equal the ratio of
the mortgage reduction to the current appraised value of the home. Upon the sale of the home – and after
retiring the mortgage - each party would receive their appropriate share.
This solution is not a shared equity mortgage – it is a standard mortgage and a fractional equity interest
security. The mortgage holder carries the fractional interest as an offset to the mortgage reduction. Both
or either the mortgage and the fractional interest security later could be sold into their respective capital
markets, if the mortgage holder so chose. The homeowner could retain a right to repurchase their
fractional equity interest based on an appraised value (fair market value) in the future.
Homeowner
can't afford
payments or
Home value loses desire to
declines to remain
$160,000 but quot;flippedquot; in
homeowner house with
still owes negative
Home is $200,000 on equity. Only
purchased for mortgage. options are
$200,000 with foreclosure or
a 100% loan of modification.
$200,000.
The HEFI now provides a new option for both the homeowner and the lender
and incentivizes both parties to work toward a mutually beneficial solution.
EVERYONE WINS!
•Lender either gets the loan off their
LENDER HOMEOWNER books or enjoys the benefits of a
new performing asset.
•Restructures loan to 90% ($144,000) of •Gets new loan with a 28% •Lender has an economic back‐end
current value ($160,000). reduction in principle and vehicle that is considered a
•Take writedown of $56,000. monthly payments tangible asset to offset any write‐
•Create HEFI as a vehicle to recapture a (assuming same interest downs. This is the ultimate
portion of the amount written down. The rate). BALANCE SHEET SOLUTION!
HEFI is structured as a 35% ($56,000 / •Grants investor a HEFI with •Homeowner stays in home and can
%160,000) fractional ownership of the option to share in equity and afford their monthly payments.
home (this is only an estimate and future appreciation as an
appropriate economic offset. •Foreclosure is avoided thus helping
individual calculations may vary). to stabilize and possibly increase
the value of homes in the
neighborhood.
www.homeequitysales.com

2. The Housing Crisis: A Downsize-in-place Solution
John O’Brien
October, 2008
Despite the enactment of Treasury Secretary Paulson’s program to relieve our nation’s
financial institutions of their toxic assets, there is a consensus that, by itself, it is
insufficient to stem the U.S. economic crisis. The underlying problem that still needs to
be tackled is the country’s residential housing crisis; specifically, distressed homeowners
who cannot afford their mortgage payments. This problem has been compounded by a
downward spiral of falling house prices that has often resulted in negative equity even for
those homeowners who are able to afford their payments.
Although congress passed housing legislation this summer to alleviate these problems,
mortgage originators don’t appear fond of the program’s FHA-guarantee plan. Unless
something more is done, families will continue to lose their homes to foreclosure,
residential real estate prices will continue to fall, banks will continue to lose mortgage
clients (and be saddled with properties) because of the perverse incentive of negative
equity to walk away from a home, and thus financial institutions will continue to be
plagued with toxic assets.
What should be done about the housing crisis, if anything? Is there a responsible and
practical approach to the problem? Regardless of cause, many people now suffer from
having “too much house,” meaning that they can no longer afford their mortgage
payments. A desirable solution to the current crisis would diminish the mortgage burden
of distressed but responsible homeowners while allowing them to remain in their homes;
in other words, the solution would enable them to “downsize-in-place.”
How could a downsize-in-place mechanism work and yet be fair to both financially
strapped homeowners — as well as anxious lenders — and not be a taxpayer-financed
bailout? Consider the example below.

3. 1. George and Mary Bailey purchased a home for its appraised value (with no down
payment), originating a $300,000 mortgage with the Potter Building & Loan
Association.
2. Now, the Baileys cannot afford their mortgage payments.
3. The Baileys are willing and able to carry a mortgage at the home’s currently
appraised value of $265,500 (a decline of $34,500, or 11.5%, from its original
price).
4. Needing to mitigate the deterioration of its balance sheet, the Potter Association
retires the original $300,000 mortgage and replaces it with a new $265,500
mortgage. And, in return for forgiving the $34,500 difference between the old and
new mortgage amounts, Potter receives a security from the Baileys for ownership
of a minority, fractional-interest in the home. Since the fractional-interest security
is an equity stake, it does not burden the Baileys with any principal or interest
payments.
5. The fractional-interest percentage is determined by the amount of mortgage loan
forgiven as a fraction of the current home value. In this example, the fractional-
interest is 13% ($34,500 divided by $265,500); the homeowner’s fractional
interest is 87%.
In essence, the Potter Association and the Baileys become partners in the home. They
each hope for, and have a stake in, the home’s price appreciation.
When the house is sold, the Potter Association would receive all of the sale proceeds up
to the “break-even” amount of $305,172 ($305,172 times 0.87 equals $265,500, the new
mortgage amount), assuming the Baileys still owe $265,500 on their mortgage.
Naturally, the break-even amount declines as the mortgage principal is paid off.

4. If the home later sells for $350,000, for example, the Baileys would receive a net of
$39,000 ($350,000 times 0.87, less the $265,500 mortgage). Correspondingly, the Potter
Association would receive the $265,500 mortgage repayment plus $45,500 ($350,000
times 0.13), for a total of $310,500. In this example, the lender receives $10,500 over the
original $300,000 mortgage — a premium for bearing the risk of the $34,500 forgiveness
in the mortgage restructuring transaction.
Conversely, if the home later sells for $275,000, the Baileys would receive a gross of
$239,250 ($275,000 times 0.87) but because they owe $265,500 their net is zero. The
Potter Association would receive the entire $275,000 – the mortgage amount of $265,500
plus a portion ($9,500) of their 0.13 share of the sale price. This is a much better scenario
for Potter then what they would have received in a foreclosure.
The general result is that the lender receives all sale proceeds up to the level of the new
mortgage’s outstanding principal; after that, the proceeds are divided according to each
partners’ percentage holdings.
The fractional-equity solution is a win-win scenario whether or not the property rises in
value after the mortgage restructuring: the homeowner benefits by being able to keep
their home; the lender benefits by avoiding the costs and uncertainties of foreclosure.
The HEFI also allows for the flexibility that is typically expected from homeownership,
such as being able to sell your home at any time. This can happen at any time as long as
the home is sold at Fair Market Value. Another advantage is that the HEFI allows for the
homeowner to repurchase or buy-out the HEFI owner thus regaining control of 100% of
their equity and appreciation. These attributes, along with others, lend to the HEFI
facilitating a true “partnership” between the lender and the homeowner as they both share
in the value of the home, for better or for worse.
Since the financially distressed homeowner “paid” for her mortgage forgiveness by
reducing her home ownership percentage — i.e., “downsizing-in-place” — there is no
reason for other homeowners, or taxpayers in general, to feel that they are being
disadvantaged. There is no bail-out; it’s a private-sector buy-out.

5. The home fractional-interest security principal is perhaps even more useful beyond the
immediate foreclosure crisis. For example, home-equity partnering could help
prospective buyers afford a home suited to their needs. (In an informal way, some parents
already do this for their children and some universities for their professors).
For retirees who enjoy substantial home equity, home-equity partnering could provide
them with liquidity in the form of a lump-sum payment to supplement their reduced
income, or to allow immediate giving to children and grandchildren.
Home-equity partnering could help single-family home developers arrange financing
beyond debt for qualified first-time buyers. It could even benefit high net worth
individuals by allowing them to spread the risk of wealth concentrated in a single
property.
In all these cases, since the financing is equity and not debt, there is no leveraging or
additional loan principal or interest payment.
Crises often ignite innovation. The current mortgage foreclosure crisis should lead to
better options for consumer home financing, options that include equity as well as debt.
John O’Brien
Managing Partner
Home Equity Securities, LLC
Adjunct Professor and Faculty Director
Master's in Financial Engineering Program
Haas School of Business, U.C. Berkeley