Under the present proposal, the existing loans would be refinanced for longer periods of time and at lower interest rates. With the periodic payments on the new loan maintained at the same level as those of the existing loans, the resulting longer term and lower interest rates will permit an increase in the loan principal. That increase would provide the additional money needed for basic repairs and building improvements. Various factors will influence the amount of repair and improvement money that can be derived through this mechanism. First, as the principal on the existing loans increases, the amount of repair and improvement money that can be made available by refinancing will also increase. Second, the higher the present interest rate is on the current debt, the greater will be the amount of repair and improvement money made available on refinancing. For example, a $3,000 loan for five years at 15 percent interest would require monthly payments of $75. If refinanced at 8 1/2 percent interest with a 1/2 percent mortgage insurance premium (MIP), $3,000 would become available for repairs and improvements. If the current interest rate were 20 percent, the repair and improvement money obtainable would be $3,630. Third, as the term of the existing debt increases, the amount of repair and improvement money made available decreases. To illustrate, if a current three year, $3,000, 10 percent interest loan were refinanced for an additional five years at 8 1/2 percent with a 0.5 percent MIP, $3,859 of new money would become available for repairs and improvements. In contrast, if the current term was seven years, refinancing for an additional five years would produce only $1,500 of repair and improvement money. Finally, the longer the new term is after refinancing, the more repair and improvement money that will be made available. The repairs and improvements to be made under the program will be too limited to extend the lives of the upgraded buildings for 20 to 40 years, as is required under the existing rehabilitation programs.19 In many cases, even with the proposed repairs and improvements, continued occupancy for a period longer than perhaps 15 years would be intolerable. The term for any particular loan would be determined by the lender's judgment as to how long the property will continue to be occupied and produce sufficient revenue to support payments on the mortgage. To provide some protection to FHA, a 10 to 12 year maximum period for the new loans could be established. The condition of buildings and the costs of making repairs and improvements will, of course, vary. For purposes of this analysis, it is assumed that the minimum amount needed for repair and improvement would be $2,000 per unit. Existing loans with small monthly payments will not be sufficient to produce the needed mini 19. See notes 27-31 infra and accompanying text. mum repair and improvement money. Under these circumstances, a solution exists which involves increasing the monthly debt service.20 A final limiting factor is the length of the amortization period of the existing loan. As that term increases, two problems arise. First, the additional term needed to produce a constant amount of repair and improvement money increases. Second, the overall length of the new loan will be increased because the term of the existing loan is longer. A 5 year $3,000 loan at 10 percent interest would produce $2,200 of repair and improvement money if it were refinanced for 10 years at 8 1/2 percent interest with a 0.5 percent MIP. In contrast, if the term of the existing loan were 7 years, approximately 9 years would have to be added to the term of the existing loan to produce $2,200 of repair and improvement money. The overall term of the new loan would be 16 years. The result is that some loans will have existing terms too long to make the refinancing-repair and improvement approach feasible. The impact of these limitations on the proposed program is not likely to be substantial. If mortgages with favorable terms are widely encountered, the impact of the proposed program would be substantial. Whether this will occur cannot, however, be established in advance because of the inadequacy of data on mortgage terms of inner city housing, especially in "red-lined" areas.21 The refinancing mechanism will produce the greatest amount of improvement money where the present debt is on a short-term basis and at a high interest rate. In some situations, the high interest rate is expressly provided for in the mortgage note. Where this is so, the benefits, consisting of increased principal obtainable by refinancing on better terms, can be directly and readily realized. If, however, the effective interest rate is high, but the interest rate expressed in the note is moderate, the full benefits of refinancing on better terms can be achieved only if certain additional steps are included. An effective interest rate higher than that expressed in the note may occur in at least two ways. First, the owner may have financed his purchase of the building with a note and purchase money mortgage taken back by the seller. If, because of the high risk involved, the seller would have preferred payment in full, he is likely to have increased the sale price of the property in return for his agreement to take back part of the price in the form of a note from the buyer. The result of that inflated price is that the real market value of the property received by the buyer is less than the total of his downpayment and the note he has signed. That excess, and the interest he is obliged to pay on 20. See Different Financing Situations infra. 21. See note 9 supra. 66-138 O 71 pt. 2 - 13 the excess, is, in effect, a further charge for borrowing the money needed to purchase the property.22 An effective interest rate higher than the expressed rate might also be secured in situations in which the purchase is financed with a loan from a third party. Thus, the buyer and the seller would agree upon a purchase price. The buyer would pay part of that price with his own money and the rest with money borrowed from a third party. The third party, in agreeing to make the loan, would demand a discount from the borrower for making the money available. The borrower would receive the amount necessary to cover the difference between the purchase price and the cash down payment. The amount of the note, however, would exceed the amount of cash received by the bor rower to the extent of the discount charged. That excess and the interest paid upon it would, again, represent an additional charge for the money needed to purchase the property.23 If the full amount of these existing loans were to be refinanced for longer terms at market rate interest, additional principal would be made available only as a result of extending the amortization period The high effective interest rate would remain, and thus the chance to achieve additional savings by reducing that high rate would be lost. In addition, the lender may obtain repayment of some funds he never realistically expected to receive, given the high risk character of the loan. Loss of the full benefits obtainable through refinancing could be avoided and any windfall prevented, if, as part of the refinancing, the lender were to agree to accept less than the outstanding indebtedness on the note in return for immediate repayment in cash Such a bargain should be possible if the conditions of the building and its neighborhood have sufficiently jeopardized the lender's security so as to make the prospect of an immediate cash repayment attractive. The risk that the lender may be liable for property damage or personal injuries resulting from the substandard condition of the building24 may provide an additional incentive to accept repayment 22. See STERNLIEB 116-17. 23. See id. at 114-16. If the lender did not wish to charge the discount directly, alternative devices might be employed. Under one method, the purchaser would provide a cash down payment and a note for the remainder of the price, which the seller would then sell to the third party lender. The purchase price would be set sufficiently high to ensure that the total amount by which the lender discounted the note would not reduce the total amount of cash received by the seller to less than the price at which he would have sold the property in an all cash transaction. The amount of the discount and the interest paid upon it are additional costs to the purchaser of financing the purchase. Alternatively, the seller could transfer the property to the third party lender who would in turn sell the property to the true purchaser. The price in the first transaction would be the price of an all cash transaction. The price to the ultimate purchaser would be increased by an amount the lender considers necessary to cover the risks involved in making such a loan. That price differential, and the interest paid on it, again would constitute an additional cost to the purchaser of financing the transaction. 24. See Morocco v. Felton, 112 N.J. Super. 226, 270 A.2d 739 (1970); cf. Connor v. Great Western Sav. and Loan Ass'n, 69 Cal. 2d 850, 447 P.2d 609, 73 Cal. Rptr. 369 (1968). at less than par.25 To ensure that advantage is taken of this opportunity for savings, the owner should be required to certify, as a condition precedent to the FHA guarantee, that he has used his best efforts to secure agreement from the lender to accept less than the full amount of the outstanding debt in respect of the refinancing. The owner would be required to use any money saved for repairs and improvements rather than for extraneous personal purposes, and, to that end, should certify both the amount expended in satisfying the existing debt and that the excess was spent on repairs and improvements. To further minimize the possibility of undue benefits to lenders, and to ensure realization of the full savings potential, the new mortgagee might be required to certify that, in light of the circumstances and upon the information available to him, it is his best judgment that the owner has secured from the prior lender the best possible terms for repaying the original loan. The mortgagee could be directed to consider any evidence of hidden financing charges created by inflated prices or substantial discounts. To make certain that the mortgagee had access to relevant information, the borrower and the original lender could be required to submit information to the mortgagee, under penalty of perjury, about the transaction from which the loan arose. That information could include the purchase price, the down-payment made, and the size of the original note. The mortgagee would have to consider, as well, the probability that the lender would eventually collect all of the outstanding debt if it were not refinanced. The accuracy of the certification should not be made a condition of the validity of the FHA guarantee, lest the lenders be too cautious or reluctant to enter the program. However, gross carelessness about its accuracy or intentional falsification could be a ground for imposing criminal penalties or blacklisting the lender from future FHA operations. The Repairs and Improvements Contemplated The refinancing program contemplates repairs and improvements which will substantially improve living conditions26 for people who 25. If the mortgagor is a member of a minority group, a reduction might also be legally enforceable under the rationale of Contract Buyers League v. F&F Inv., 300 F. Supp. 210 (N.D. Ill. 1969), aff'd sub nom. Baker v. F & F Inv., 420 F.2d 1191 (7th Cir. 1970). The case involved black homebuyers who had been sold houses at inflated prices by sellers who were exploiting the pattern of racial discrimination in the market. Relying on the Civil Rights Act of 1866 and the thirteenth and fourteenth amendments, the court held that selling residential property to blacks at higher prices and on more burdensome terms than similar property is sold to whites is illegal. As a result, the seller would be ordered to repay the price differential to the buyers, if the allegations of the complaint were proven at trial. 26. There is much current discussion of new technological innovations in now, and in the future, will continue to live in substandard housing. Yet these improvements will be made with per unit expenditures substantially below those in the HUD rehabilitation programs.2 27 Doubts that lower expenditures can produce significant improvements will be dispelled when the aims (and therefore needs) of the two programs are compared. The goal of programs such as Urban Renewal,28 Concentrated Code Enforcement29 and rehabilitation under sections 2350 and 23631 is to provide sound housing that will last for the life of a mortgage that may be amortized over 35 to 40 years. In short, they seek to provide long-term solutions. The proposed approach, in contrast, is intended to provide relief for the millions of people who have not been served by the long-term solutions. Given the various constraints under which the more expensive and ambitious programs operate, it is believed that a more modest approach is needed. A variety of factors will influence the type of repairs and improvements possible under the proposed approach. The first variable will be the condition of the particular building and the specific repairs needed. Choice of the repairs to be made will vary from building to building. Some buildings treated under the program would be worthy of full-scale rehabilitation, if money were available and a general program of neighborhood revitalization were undertaken. If such rehabilitation is anticipated in the near future, repairs that would be reused in the later rehabilitation, such as repairs to the mechanicals in the building, should be emphasized. A building located in a neighborhood likely to become commercial or industrial might not warrant materials and construction techniques for both housing production and rehabilitation. See HUD Requests Proposals for Operation Breakthrough, HUD News, June 26, 1969; Department of Housing and Urban Dev., Request for Proposal No. H-65-70 for the Study of and Reports on the Development of Optimum Approaches to Techniques for Larger Scale Rehabilitation of Dwellings, at 9-11 (May 14, 1970) [hereinafter cited as HUD Rehabilitation Study]. See generally Bryan, The Rocky Road to Low Income Rehabilitation for the Private Investor, 27 J. OF HOUSING 76, 77-82, 87 (1970). Many new techniques are already in use and, no doubt, others will develop from the experience of HUD's Project Rehabilitation. Romney Announces "Project Rehab" to Rebuild Slums on Large Scale, HUD News, July 21, 1970. These new techniques should reduce the costs of repairs and building improvements and offer some promise of an increased return for each dollar expended. They will not, however, obviate the need for interim assistance, as here proposed. 27. Rehabilitation costs in connection with urban renewal and other projects averaged $10,833 per unit for a Warner & Swazy project in Cleveland, see Bryan, The Rocky Road to Low Income Rehabilitation for the Private Investor, supra note 26, at 76, 79; $9500 per unit for a Camden Home Improvement Project's effort in Camden, New Jersey, id. at 87; about $11,000 per unit for Philadelphia's Used House program, id. at 89; $8,500 per unit for Pittsburgh's AHRCO projects, Wall St. J., Sept. 3, 1970, at 15, col. 1; $9,600-13,700 per unit for the Low-Income Housing Demonstration project undertaken by the South End Community Development, Inc., in Boston, WHITTLESEY, THE SOUTH END Row HOUSE 4-18 (1969); and about $7,750 per unit for the famed BURP project in Boston, Goldston, Burp and Make Money, HARV. BUS. Rev., Sept.-Oct. 1969, at 89, 97. 28. Housing Act of 1949, 42 U.S.C. § 1450 (1964), as amended, (Supp. V, 1965-69). 29. Housing and Urban Development Act of 1965 § 311 (a), 42 U.S.C. § 1468 (Supp. V, 1965-69). 30. Housing and Urban Development Act of 1968 § 101 (a), 12 U.S.C. § 1715z (Supp. V, 1965-69). 31. Id. § 201(a), 12 U.S.C. § 1715z-1 (Supp. V, 1965-69). |