The VC Mortgage People Are At It Again
A look at an... interesting plan to assume mortgages at scale
Did You Assume My Mortgage?
An interesting article appeared in the Wall Street Journal yesterday outlining the launch of Roam—a startup with a vision to make mortgage loan assumptions great again. The article is a good intro to mortgage assumptions as well as the high-flying mind of the VC investor.
In case you’ve been in space or solitary confinement for the last eighteen months, I’ll just say up front that mortgage rates are currently in the 7-8% range. Homebuyers are beginning to balk at the math behind monthly payments for home purchases which only two years ago would have cost them monthly payments almost half of what would be incurred today. This has caused a bit of slowdown of late in new home buying activity.
Mortgage assumption, then, is a way to circumvent today’s higher rates. The concept is a relatively straightforward, and, honestly, clean idea that has been around for a long time but hasn’t ever really taken off (more on that later) with large pools of homebuyers and sellers.
It works like this. Let’s say you own a house with a 2% mortgage, and you’d like to sell your home to me. I can go to the bank, get qualified for a loan at current rates and then purchase the house from you. You would then take the proceeds from my mortgage, pay off your mortgage, and pocket whatever remains leftover. This is the typical course of business.
An assumption simply changes the owner of the mortgage from yourself to myself, and then I’m responsible for paying you the remainder of the sales price.
While it might sound good on paper—it sounded good enough to entice Founders Fund into the seed round—it’s actually pretty cumbersome. (Oh, the founder of the company came from Opendoor and got money from a co-founder of that company, so… make of that what you will.) If you owe $100,000 on your home and are selling it for $400,000, I’m on the hook for coming up with $300,000 of cash to complete the transaction.
All of that is great if I just have $300k sitting around, but I’m not Scrooge McDuck, just swimming in piles of money over here.
So, I must then turn to a lender for the money. This is where it gets complicated.
First up is the question of liens. Let’s say your mortgage (the one I assume) is with Wells Fargo, and I get a mortgage from Chase to cover the difference between what you owe and the purchase price. Then let’s say that in a few years some terribleness befalls me, and I default on the loan. A few problematic questions are immediately clear:
Which bank will take control of the collateral (the house)?
Which bank has priority of claim?
The obvious answer is the first bank that holds your mortgage, which puts the other bank in the unenviable position of lending me money knowing it is taking second place in line.
More pressing for risk each bank is taking is the fact that you can’t sell a fraction of interest in a house at auction, and no bank has the appetite to hire a bunch of people whose sole job is to chase down other banks who owe them a percentage of the funds secured from selling off foreclosed properties. There’s also a roughly 0% chance that these banks would ever agree to split anything to begin with—second lien holders take what they can get, which would invite costly litigation over a relatively meaningless dollar figure.
Now, if Chase agrees to loan me $300,000 in unsecured funds, they’re gonna give it to me at a higher rate than traditional mortgage rate. The math would have to be pretty aggressive in that case for the assumption to make financial sense for me as a buyer in that case. It’s eminently possible that I would just be better off taking out a whole new mortgage at prevailing rates and forgoing the assumption process completely. So it only naturally follows that most of the time if will be preferable for a buyer to get an additional mortgage loan vs. the unsecured loan option if they do not have the excess cash readily available.
Now, there are pockets of the financial world where bitter fighting and squabbling over portions of debt happens daily—the world of corporate credit. In this realm battalions of lawyers for PE outfits or investment banks or whoever duke it out over what kind of wording goes into bond indentures late into the night. They make sure that in the event of a future corporate default, every interested party already understands what they’re entitled to (and even then litigation often ensues when inevitable misunderstandings or double-crossings come to light).
For this work, these lawyers and investment bankers are paid handsomely. Like Jimmy Garoppolo handsomely.
In other words, squabbling over seniority in a debt stack is commonplace in crannies of finance where the stakes are high and there’s a lot of money on the table but come on people no bank is going to willingly put in a fraction of this kind of effort into individual mortgages.
There. I said it. There just isn’t enough juice to make the squeeze worth it.
In my exceedingly humble opinion, the whole concept stinks of a Silicon Valley solution in search of a problem. The residential mortgage origination industry is famously slow and dated, which may seem at first glance like low-hanging fruit opportunity for innovation, but I think this is largely a feature rather than a bug because participants in the market largely don’t want innovation.
The mortgage industry is comfy, sleepy, and stuffed with healthy fees for each party involved in the origination process. As the WSJ article noted, fax machines are often employed in the normal course of business.
Fax machines. In the year of our Lord 2023.
Of course, this isn’t the first time that Silicon Valley-types have dipped their toes into the broader real estate ecosystem, but it is an area of investment where the industry seems to have fallen short more often than not, as the fragmented nature of real estate makes it difficult to leverage the kind of economy of scale sought after in traditional tech businesses.
In the end, though, that doesn’t mean that they’ll stop trying. It just seems unlikely they’ll find what they’re looking for.