Home price index swaps, treated as a second lien on a property, will be used to reduce the default risk associated with low down payment mortgages, one of the program’s creators said.
Risk Reduction Mortgage Corp., based in Manchester, N.H., is the marketer of the second mortgage product. A first mortgage lender would originate both pieces, said CEO Marc Biron. The originator would use its normal exit strategy — secondary market sale or portfolio — on the first mortgage.
The second, marketed as the Risk Reduction Mortgage, would be held by RRMC. A home diversification agreement is created with the borrower who at the time of origination purchases a local home price index that is then exchanged with RRMC for a national index. A national index has 65% lower volatility than a local index and therefore is less risky for all parties, Biron said, creating an alternative to other forms of credit enhancement for low down payment mortgages such as private mortgage insurance and the Federal Housing Administration program.
When the borrower sells the house, if the market outperforms the national index, they will compensate RRMC. But if the national index outperforms the market, the borrower would be compensated, he explained.
Each month, RRMC reports the swap value to the first mortgage servicer. It then receives a 6-basis-point fee paid by the borrower.
Creditors such as the government-sponsored enterprises will see up to a 70% reduction in systemic credit losses, RRMC said in a press release. There are plans to start originating this product in 2019.
RRMC is currently raising money in an angel/seed round, meaning only accredited investors as defined by the Securities and Exchange Commission can invest in the company, according to the company’s website.
“We are offering a solution to diversify the largest, most concentrated asset class,” Biron said. “So there are benefits for everyone involved,” including the originator and servicer. “Everyone gets a benefit from this risk reduction.”