Alternatives To The 30-Year Mortgage For Homeownership

We’ve taken a look at the history and function of mortgages, the problems with financing homeownership with them, and the powerful sentiments that keep people who truly want to build wealth demanding them even while they may not be the best solution. What about alternative methods of financing ownership of homes? As we saw in the discussion of the strong feelings of homeownership, any alternative would have to lead to something that would give household’s a sense of security and empowerment. There are some models of cooperative financing and fractionalized ownership that could offer an exit from the 30-year mortgage as a strategy for lower income households struggling to achieve transferable generational wealth

Fractional Ownership

Fractional ownership is a thing, and as defined by Investopedia it is “when an investor purchases a percentage or share of an asset instead of paying the full price. This enables those with less access to capital or looking to diversify over several kinds of assets to get a stake in areas like real estate, aviation, and fine art. Depending on the type of fractional ownership, the owner may also obtain partial usage rights in addition to an equity stake.”

I use the term or the term “fractionalized ownership” to describe the idea that individuals can acquire ownership of real estate by pooling resources with each owning a share. That share could be in the denomination of a unit of housing. But the term could also apply to the fractional ownership of a unit. The term could also apply to ownership of debt, like many people taking out a loan, or making a loan to individuals or groups. Breaking the spell of the 30-year mortgage will require managing investment and risk in a different way, likely more collaborative and localized options rather than from a remote federal government.

Housing Cooperatives

In a housing cooperative, residents own a property as members of a corporation; a simple version is that if a building is worth $1,000,000, and there are 5 residents with 5 shares, each share is worth $200,000. Unlike fee simple ownership, if there are 5 units, the resident living in a unit doesn’t own it the way they would owning a piece of property with a house on it. Instead, the shareholder has a legal agreement entitling them to use of the unit and common areas. Operating costs can be covered by dues. National Capital Impact has a fine rundown on cooperatives here.

The advantage of this model is that monthly housing payments can be financed through a loan from a bank or from the cooperative itself, as a resident purchases shares, that will lead to full vesting in a particular unit. Other models require a larger up-front investment. Cooperative structures can be very simple or very complicated depending on how they are organized. The advantages are that as a property appreciates, so do individual shares, so equity can build. If financing is with the cooperative rather than a bank, fellow residents can create more flexible terms for financing rather than rigid ones set by a bank.

I’ve suggested that a model that could supplant mortgage financing would be publicly financed cooperatives. A local jurisdiction would borrow money (low interest revenue backed bonds would be best), build a housing project, then allow residents as a cooperative to pay down all the debt or part of it over time and own the project outright. The local government would absorb the initial risk providing low-cost financing which would mean real ownership with shares that could appreciate, be transferred, or sold.

Real Estate Investment Trusts (REITs)

In today’s financial markets, Real Estate Investment Trusts or REITs, are traded just like shares of stock. Instead of owning a share of a company, the investor owns a share of a real estate investment. Tax rules require that appreciation and funds earned from the operation of the real estate be returned as dividends to shareholders. The nice thing about this kind of ownership is that shares can be sold almost on a whim; no real estate agents or inspections or negotiating. The REIT model allows a fixed asset to become more like a liquid asset.

I’ve described what I called, years ago, a neighborhoods real estate investment trust, that would allow ordinary people to contribute in smaller increments to a fund that could buy, own, and operate real estate assets. This could be done with housing as well. If 50 people pooled their resources, purchased housing, they could own it for themselves or rent it to their neighbors for affordable rents. Residents could buy shares and become owners themselves and, like a cooperative, have agreements in place to live in a unit. What the REIT model would allow is the aggregation of local capital to buy and own housing without involving the federal government or even a large financial institution. Here’s a good explanation of how Real Estate Investment Trusts work today.

Building and Loan Associations

We covered the building and loan model in a previous post. This model was how people purchased detached single-family homes until it was displaced by mortgages during and after the Great Depression. The idea is that community members would pool their money and savings in an institution that would then, in turn, loan that money out to others in the community for the purchase of homes. As interest payments accumulated from the loans, share values would increase and could be applied to remaining balances. Depending on the success of loans and healthy dividends, households could fully own a fee simple asset in as little as 15 years.

There are many risks in this model but there are in any financing structure. The advantages of this, like the others covered so far, is that both risks and benefits are local, and this containment means decisions get driven by local market factors rather than national or global ones. If a loan fails, the institution and the community have an interest in rescuing it. If the local economy begins to fluctuate, growing or shrinking, constituents will have interests that follow those trends. If housing demands increase shareholders are likely to benefit from expanding the pool of loans rather than suppressing new construction to push appreciation. If the economy suffers a downturn, dividends might fall and payment times might lengthen, but there would be fewer foreclosures. The Federal Bank of Richmond has a short but thorough history of the way buildings and loans worked before the mortgage.

Rotating Savings and Credit Association (ROSCA) or Korean “Keh”

The “keh” is an example of a rotating savings and credit association (ROSCA). The Korean and other Asian and immigrant communities have used this with great benefit. The way it works is a a group of individuals or families pool money and then contributes to the fund regularly. Once the fund is sufficiently capitalized, lots are drawn and people are given access to the fund for an investment – like buying a house or business – and that individual or household pays back the fund. When the fund is recapitalized, the next individual or household in line gets access to the fund. The system relies on risks and benefits that are highly localized.

The ROSCA model typically doesn’t charge interest. But if the local government was to create a fund and partially capitalize it and allow local families to contribute to it, the fund could be used just like a ROSCA. The advantages of this method of financing would be that the local government could absorb the risk, modifying the process and standards of lending based on local needs. It would also allow families to put limited resources to work with the maximum benefit.

What Do These Models Have in Common.

These are all just ways of lending money for the acquisition of something that a person doesn’t have the cash to pay for right away. All financing schemes are pretty much that simple. The challenge is finding the capital to make the loan, managing the risk effectively, and being able to create returns for people making the loans that are commensurate with the risk. Scaling these relationships is hard, which is why the 30-year mortgage backed by the federal government has worked for so many; the backing of the government of the largest economy in the world lowers risk substantially enough to make millions of six figure loans. We’ve reviewed the downsides. How might these models achieve the goal of shifting away from the mortgage.

• Local risk, local benefit – Every microeconomy has lots of money flowing around in it, including poor people’s money. The problem is how can lots of people with a few dollars put them together to create enough scale to lend effectively to local neighbors for housing. These models could do that.
• Faster ownership – In each of these models, the possibility of real ownership in a shorter time frame is increased. The mortgage pushes the risk back on the borrower by piling up all the interest on the front end meaning real ownership is in a far-flung future or only possible with hyper appreciation caused by widespread scarcity.
• Cheaper money – With local instead of federal government backing, community lenders and borrowers can benefit from government backing that is closer to home. Yes, all lending and borrowing is risky; local governments could make bad lending decisions and wind up bankrupt. But local government financial troubles from capitalizing these kinds of schemes is unlikely to create a global depression.

None of these options an overnight solution to ending the mortgage. And mortgages will continue to work for many if not most people. But beginning to explore these sorts of local options could create alternative paths to ownership that could address persistent disparities and negative downstream consequences of using only long term, 30-year mortgages backed by the federal government to create real homeownership