B of A tests foreclosure alternative

This post comes from Marilyn Lewis of MSN Money.

Bank of America, which owns a million mortgages and services an additional 9 million, is experimenting with a new alternative to foreclosure called "mortgage-to-lease."​ A select group of defaulting owners is getting the chance to turn in the keys to their homes in exchange for having their outstanding mortgage debt forgiven. They can live on in the homes as renters, at or below market rental rates, for up to three years.  (Post continues below.)

Who's in, who's out

Some 1,000 handpicked borrowers are being offered the rental option. B of A isn't taking applications. The bank says the group includes borrowers who:

• Have a mortgage owned by B of A (no securitized loans).
• Are at least two months in arrears and at significant risk of foreclosure.
• Live in the home (investment properties aren't eligible).
• Have a first mortgage only (second mortgages or lines of credit aren't allowed).
• Live in New York, Nevada or Arizona.
• Can afford the proposed rents.
• Have tried -- or have not responded to efforts to get them to try -- alternatives like loan modifications, short sales or deeds in lieu of foreclosure.

CNNMoney says "there are nearly 200,000 homes in Arizona, Nevada and New York for which the homeowner is 60 days or more delinquent on their home loans."

For owners, it would be the chance to avoid the stain of foreclosure on their credit reports. The Naked Capitalism blog lists other upsides:

They escape the credit score damage, stress, and indignity of the foreclosure process and save moving costs. They are also spared the difficulty of finding a landlord who will accept a tenant with a tarnished payment record.

Ron Sturzenegger of Bank of America told The Wall Street Journal:

We're optimistic but realistic. If we get a great takeup rate and the process works, we'll roll it out.

Bank of America said it would sell the homes to investors if the program takes off. Bank spokesman Dan Frahm told The New York Times:

There isn't much of a question about investor interest. What we're testing for is customer interest.

Is it good for homeowners?

But will defaulting homeowners take the bait? Washington Post real estate writer Kenneth Harney speculates about how eligible borrowers might react:

Would you say yes?

Or would you instead conclude: Hey, why pay rent? It's going to take the bank more than a year to complete the foreclosure and evict us, so why not just stay put and save some money?

If the trial works out, "it could become a model for the biggest players in the mortgage market -- Fannie Mae and Freddie Mac," says Harney.

The upside for the banks is plain, he adds:

Since foreclosures generally trigger deeper losses to lenders than deeds in lieu of foreclosure, the bank gets back troubled properties at lower costs. Since it intends to sell those houses to investment groups as rentals with existing, income-qualified tenants, the bank expects to obtain overall higher returns than it would by selling them as vacant post-foreclosure units.

Meet the new landlord

Naked Capitalism is a doubter. Mortgage-to-lease plans could do good by keeping homes occupied and preventing the neighborhood degradation that follows foreclosures, writer Yves Smith allows. But he isn't sure Bank of America has what it takes to be a successful landlord.

Investors buying far-flung single-family foreclosures are in for a very different experience than managing apartment blocks. Rentals are a service-intensive business, he says. Big banks have a poor service record in managing their current inventory of foreclosed homes and in responding to struggling mortgage owners reaching out to them for help.

Smith asks, "How responsive will they be when a boiler fails or the roof develops a leak or a tree falls down in a storm and damages the house?" 

Big-scale game changer?

As for the big picture, could the mortgage-to-lease idea be a silver bullet for our housing troubles? Residential rentals suddenly are the rage among investors and the hope for absorbing and refurbishing the nation's massive oversupply of homes.

The market for foreclosed homes is "red hot," Reuters says in "The Wall Street gold rush in foreclosed homes." The article explains that the "U.S. government is moving ahead with a trial project to sell big pools of single-family homes that Fannie Mae currently owns in some of the hardest-hit housing markets."

Fannie Mae and Freddie Mac, the government-owned mortgage corporations, own about 200,000 foreclosed single-family homes. (Banks own an additional 600,000.)

But even if it's fair to sell these assets to investors for deep discounts -- and many argue it is not -- can the rental market solve the foreclosure problems plaguing banks, the federal government and the public?

Not as presently configured, it seems. B of A's program sidesteps two of the biggest groups of troubled borrowers: those with second liens on their homes and those whose loans are owned by pools of investors.

Says Naked Capitalism:

It is hard to imagine that balance-sheet-stress​ed Bank of America would include properties that had bank-owned second liens on them, since the second would be a total loss. Borrowers with second liens have much higher default rates than those with first liens only, so many borrowers in need of help are likely not to be invited to participate.

More on MSN Money:

• Calculator:Should you rent or buy?
• Should you buy a foreclosure?
• Foreclosure sales flood market
• Church foreclosures growing
• Uncle Sam stuck with 248,000 homes
• Today's lowest mortgage rates