At Habitat for Humanity, families purchase their homes via sweat equity, a very small down payment, and a non-interest bearing mortgage payable to the Habitat for Humanity affiliate.
In the real world of business, there is no such thing as a zero interest loan unless it’s to kids from the Bank of Mom and Dad.
Habitat must comply with the same generally accepted accounting principles as every other business.
The market value of a Habitat loan is NOT equal to its face value. There is a real cost of money associated with Habitat mortgages. As such, the Habitat mortgages must be discounted to their market value.
“Market value”. Is there a “Market value”? Yes – absolutely.
Market value is based on the concept of present value as it relates to the future mortgage payments.
To determine present value of a Habitat Mortgage, consider the current interest rate of a conventional mortgage. If the current interest rate is 4%, then the cost of money related to the mortgages is 4%.
Habitats can easily determine the value of an outstanding mortgage by calculating the present value of those future payments based on the current market interest rate.
For example, a house is priced at $250,000 with a down payment of $2,500 (1%). The mortgage to be paid to Habitat would be $247,500 over 30 years (360 payments). Each monthly payment would be $____ as 100% principal payment to Habitat and no interest.
How does this help us determine the present value?
List the givens:
Rate (Market interest rate): .04/12 (has to be turned into a monthly rate because payments are on a monthly basis)
Nper (Number of Payment periods): 360
Pmt (Monthly payment):
FV (Future value at end of payment period, zero since the mortgage would be paid in full after month 360): 0
Type (Timing of payment – 0 at the end of the period since mortgages at banks are paid in arrears; 1 if payments are made at the beginning of the period.)
You have now calculated the present value of that loan. The auditors do this anyway for the audit, but you can use this present value to leverage cash and reduce your dependence upon donations.
1) You can approach banks to lend directly to families for a bank loan face value equal to the calculated present value. The bank would have to agree to the same specified terms (monthly payment, same market interest rate (4% in this case), 360 payments). At close of escrow, Habitat gets the present value amount from escrow since the bank funds escrow and the bank collects the future payments.
2) If you have an established agreement with a bank to lend directly to the families, then you can BORROW on a construction loan to help pay possibly 30-35% or more of the cost of construction. That means a 30-35% DECREASE in the donations required to build a home. Donated dollars then stretch further to build more homes.
Why would banks lend directly to families?
1) CRA credits – The Federal Government requires banks to support housing in a few ways. The subprime lending of the early 2000s earned banks their required CRA credits, but banks did not want to hold on to these risky loans. The subprime loans were just that – lesser quality loans because of higher risk associated with the families’ income, credit and savings. As a result of a significant default rate on these subprime loans, banks pulled back on lending to low income families with lower credit scores and savings. However, banks still NEED CRA credits. Habitat mortgages provide access to safer loans. Habitat has vetted the families and the families have committed to sweat equity and the Habitat program. These families have “skin in the game.”
2) Goodwill and good publicity as banks become partners with Habitat for Humanity
3) The bank still makes money
What if the family gets turned down for a bank loan?
The family would still qualify for homeownership, but the loan would be from Habitat.
The Habitat loan could have value in a secondary market. More on that in my next blog. . . . .