In Detroit, people are urged to get a second mortgage when buying a house
By: Daniel Goldstein
Marketwatch, Inc
Personal Finance Reporter
The housing market in Detroit is so troubled that a new program has been created to help home buyers take out two mortgages when buying a home — one for the purchase price and one for renovations.
Detroit has the highest vacancy rate in the country at more than 12%, with more than 93,000 homes in the metro area unoccupied in August 2015, according to Trulia.com, a San Francisco–based real-estate research company. The city of Detroit, which filed for bankruptcy in 2013, has been desperate to revitalize neighborhoods and increase property-tax revenue.
The latest problem, said Laurie Goodman, director of the Housing Finance Policy Center, a research group based in Washington, D.C., is that, as a result of there still being so few comparable properties on which to base an appraisal in Detroit, the value of a rehabbed home won’t be properly reflected.
In most neighborhoods nationwide it’s easy for appraisers to determine value based on nearby homes. But in Detroit there are some neighborhoods where the home being rebuilt is the only one left standing.
As a result, a home that was purchased for $30,000 and rehabbed for an additional $30,000 may be appraised at just $50,000, Goodman said, making it unlikely buyers will be willing to invest. It’s also unlikely that lenders would write a mortgage for a property so impaired.
“This disparity creates a vicious cycle: rehabilitating is not profitable, so there is little incentive to invest in a home,” Goodman said in a blog post published by the Urban Institute, the Housing Finance Policy Center’s parent organization.
But the new program, the Detroit Home Mortgage, or DHM, will offer borrowers a second mortgage that, combined with the first loan, can exceed the appraised value of the house and help homeowners pay for the necessary rehabilitation to make the home safe to occupy.
Under the program, the borrower takes out a first mortgage with a maximum loan-to-value ratio of 96.5% of the appraised value of the home from one of five participating lenders.
The borrower simultaneously obtains a second mortgage (up to $75,000 with an interest rate of 5% and for no more than 20 years) to cover the difference between the purchase price of the home plus rehabilitation costs and the value of the first mortgage. Normally, this would be considered a big risk to the bank, but because the backers of the program — the Ford and Kresge Foundations and the Minnesota-based Community Reinvestment Fund — are guaranteeing the second mortgage, the banks can afford to take the risk of default.
The second mortgage can also be forgiven under certain circumstances, according to the DHM website. “In certain severe cases, if a home buyer experiences an extreme hardship and sells the home, the second mortgage may be forgiven,” according to the terms of the program.
Buyers need a credit score at least in the range of 600 to 640 and have to put down 3.5% on the property and take out two mortgages. The home must be located in the city of Detroit. Five local banks will do the lending. About $40 million has been set aside for the second-mortgage program, according to the DHM website.
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The strategy isn’t unique. For example, some lenders routinely factor in necessary improvements in considering a loan on an otherwise derelict property, such as a rustic cabin with no plumbing or heat, to improve the loan-to-value ratio and make the loan work.
The situation in Detroit is so dire that in 2014 the city even tried selling houses for $1,000 in hopes of luring buyers to fix up derelict properties. A check of Zillow.com shows that currently nearly 400 homes are for sale in Detroit for less than $5,000. And almost 40 homes are listed for less than $1,000. The median home value, according to Zillow, was just $37,000, down 8.9% in the past year.
The program, said Goodman, could be a major turning point for Detroit. “By allowing for mortgages with loan-to-value ratios over 100%, it could break the vicious appraisal spiral, which has systematically undervalued rehabbed homes,” she said.
