A contract that allows you to retain the purchase value of your home in a depreciating market could be financial protection well worth considering in markets where bubbles deflate.

Unfortunately, the devil is in the details and it'll likely take much more than popping bubbles to push home equity protection beyond the experimental stage where it's languished for more than a decade.

"(Depreciation) is not an insurable risk. To have an insurable risk, you must have many policy holders, but only few claims. Life insurance is the classic example. Homeowners insurance is another good example. Houses rarely all burn down at once. Home price deflation, on the other hand, is a situation where the houses can all "burn down" simultaneously. Therefore it is not insurable," said John T. Reed, an Alamo, CA-based real estate investor.

That's not stopping a group of academics and a financial strategist from running the latest incarnation of equity protection, a $5 million federally funded experimental housing futures contract called Home Equity Protection Program (HEP) which is available only to qualified Syracuse, NY home owners and buyers.

The pilot HEP is available for a one-time premium of only 1.5 percent of the protected value of your home -- $900 on Syracuse's January median price of about $60,000, the latest figure available from the Greater Syracuse Association of Realtors. Financing is available for the premium.

Participants must hold their home for at least three years. After that time, if the program's home price index shows a drop in home values, say 20 percent on that $60,000 home, the policy would pay you $12,000 -- no matter what price you actually get for your home.

The pilot is under the auspices of Yale University fiance professor Will Goetzmann; Yale management professor Barry Nalebuff; Freddie Mac director and financial economics professor at the Sloan School of Management, Massachusetts Institute of Technology, Steve Ross; and venture capitalist and Freddie Mac's Loan Prospector developer Tom Skinner.

The maximum protection program participants can buy is 150 percent of the current assessed value of the property or $200,000, whichever is less.

San Diego broker and investor Robert Campbell, who authored "Timing The Real Estate Market" considered a hypothetical futures contract scenario in the California market and found it to be a possible money maker in a down market.

Campbell says a buyer who buys at the bottom of the market, say for $200,000, and later sees prices peak at $400,000 could then buy a home equity protection contract, say for 2 percent or $8,000. Should prices then fall 25 percent (not an unlikely scenario in California) they owner could sell the home for $300,000, receive the $100,000 equity protection contract payment and then buy the same home for $300,000.

Since the original purchase, that's a $200,000 tax free profit -- minus the $8,000 premium and other costs.

"Is this an over-simplification? Probably, however, I find this kind of strategic investment thinking both stimulating and exciting," Campbell said.

That can't happen under the pilot program. Similar to but not considered an insurance policy, the contract isn't without exclusions.

The pilot program will pay out only if the contract holder can demonstrate hardship, "such as loss of employment or serious illness" which forces the sale of the home. The program determines if the hardship is sufficient to warrant a pay out. Foreclosure is also excluded.

There could be other unwritten exclusions.

"I have heard of the concept, but there were several problems. If there was a foreclosure, death-triggered loan payoff or certain other legal actions, the contract would be unenforceable," said Stephen Richard Levine, with Franzel Mortgage Consultants in Westlake Village, CA.

Levine says there also could be concerns about short sales or other issues where the lender has rights to the original value of a home when it is sold for less than the financed value. Regulatory concerns would also likely arise and it's unclear where consumers would go with complaints.

"The greatest obstacle was that the regulatory body was unclear," Levine said.

Others say simply, $5 million is much better spent in today's market.

"What a waste of government money. If that much money were put into building houses right so that they would last the length of the 30-year mortgage it would be better spent. Or how about $5 million for homeowners who have been had by their builder? The government should be giving HADD (Homeowners Against Deficient Dwellings) a grant," said Nancy Seats, president of HADD, a grassroots network of home owners with poorly constructed homes and defects that have gone largely uncorrected.

"This is ridiculous. We have done more to help homeowners than any government agency. I am sick about what government has come to, and how they are spending our money while doing nothing to protect us from substandard construction," said Seats.

Published: March 7, 2003

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