Homeless homeowners: are you ready for them? With the collapse of the sub-prime lending market, apartment managers must decide whether to welcome back these ex-homeowners--or to send them packing.

They're back. Renters-turned-homeowners are now returning to the rental market in the wake of a mortgage meltdown. Having just defaulted on a home loan, these consumers are flooding apartment managers with applications and leaving managers wondering what kind of residents will they be.

What caused the meltdown? During the past two years, lax lending standards helped to fuel all overheated housing market, which lured many consumers into houses they couldn't afford. The combination of tow interest rates, aggressive marketing of risky loan products and a lack of due diligence to verify a loan applicant's income created a "perfect storm" that made homeownership seem within reach to many Americans.

Making headlines is the collapse of the so-called "sub-prime" lending market--which caters to consumers with poor credit history and is seeing an increase in defaults and foreclosures. Some in this segment are being hit especially hard; homeowners who received tricky loans during the housing boom now are seeing their monthly payments skyrocket while their low introductory rates disappear. Meanwhile, lenders are beginning to clamp down, and the record $600 billion of sub-prime lending seen last year is on the decline.

Nonetheless, reports warn that overdue payments and defaults may worsen in the months ahead as many borrowers face higher monthly payments as their loans "reset" from the low introductory "teaser" rates. What's more, because of tighter lending standards, some won't be able to refinance into loans with easier terms.

Apartment Opportunity

The mortgage meltdown presents a tremendous opportunity for apartment managers to welcome back these former customers, but they should do so with a careful and thoughtful approach or they risk a meltdown of their own.

"Although we have not to date received many applications at our communities, we have expanded our underwriting criteria to allow for a foreclosure," said Michael Tompkins, CPM, CCIM, President, Julian LeCraw & Co., Atlanta. "Many of these folks went for the perceived American dream, homeownership. The lending practices allowed for the purchase of the home. It did not allow for any bumps in their lifestyle. We welcome their return to our apartment communities. The increase in defaults seems to be a mess that the lending industry got itself into, rather than a symptom of a sagging economy. Nationally, there has not been a slowdown in job growth that led to the increase in mortgage defaults; that is, people are not losing their jobs and then their houses. Rather, they were merely lured into purchases they could not afford."

As victims of the mortgage meltdown return to the rental market, how should apartment managers evaluate them? Would they make good residents or should they be rejected because of their mortgage defaults?

One approach is to make no changes to the resident screening process. Fair Housing guidelines require that an apartment community must screen every applicant using the same guidelines. As such, some communities use decision points along a curve of credit scores to automate which applicants are accepted, conditionally accepted and denied. Obviously, late payments and a mortgage default severely harm a credit profile, and that applicant will be denied because of his or her poor credit score.

Management companies are not forced to adjust their policies in the wake of these special circumstances, and maw are choosing not to. However, some firms are looking to capitalize on the influx of "born-again renters" and may gain a competitive edge by doing so with a well-designed program.

Creating 'Conditional' Approvals

The first step toward capitalizing on this applicant profile is to identify them. Work with a resident screening provider to provide the details of a credit record in a format that is easy to read and that shows the timeline of payment history, as well as the various credit accounts. If the community manager is using a scoring model to evaluate prospective residents, the model should include the specific factors that contributed to the score. That way, the manager can dig deeper in cases that deserve additional scrutiny.

It is dangerous for a community simply to ignore an applicant's failed home mortgage by blaming it on an out-of-control marketplace. Indeed, applicants with blemished records require careful management. After all, the most predictive information of whether a potential resident will perform the terms of the lease is if he or she has performed previous housing obligations. As such, leading resident screening providers endeavor to collect information that is housing-related--records from landlord/tenant court, eviction filings, collection accounts from apartment owners--because it is the single most relevant factor when evaluating an applicant.

It is important, however, to recognize the external factors that contributed to the mortgage crisis, as well as to understand the difference between defaulting on a lease and a loan. A lease agreement presents predictable, steady payment obligations, but a home loan can contain variable rates, many of which are masked by lower "teaser" offers.

"We're resetting our resident screening policy to disregard foreclosure as part of the criteria," said Michael Tompkins. "We're still looking at the residents' credit outside of that. We want to see what their credit was like before they bought a house they foreclosed on. If it's stellar, and it meets our criteria, we can accept them."

Tompkins said that his company also takes into account applicants' employment status as a prerequisite for renting to them.

"There is a difference between being financially reckless and financially naive," said Bob Talbott, a former property management executive at Essex Property Trust and Trammell Crow, and now a consultant to apartment owners. "Relaxed standards in the mortgage industry allowed a lot of people to step into something they never should have."

The ideal program for accommodating "born-again renters" is to recognize the consumer's special circumstance while minimizing the risk to the property owner associated with leasing to substandard renters. Such a program should be similar to existing programs that may be in place for students or first-time renters who are looking to establish a financial record.

"Foreclosures are part of a strata of criteria, so we don't hold any one thing against an applicant," said Alex Jackiw, CAPS, President, Buckingham Management, Indianapolis. "Some come to us with medical debt, student loans or bankruptcy. It's all considered. We're having an ongoing discussion with our staff about situations such as applicants with foreclosures."

Just as some resident screening providers can highlight certain account types in a background check, such as a medical collection, a factor that apartment communities commonly ignore, a screening report can flag a delinquent mortgage or foreclosure. These applicants tend to be higher risk cases, but tailoring the screening to recognize these different risk levels allows for a sophisticated program that approves more residents.

Unconventional Alternatives

The most effective programs also generate more leads, as they improve the marketability of communities and attract residents that would not otherwise qualify for housing.

For example, some communities have found great success by offering short-term "probationary" leases that are closely monitored by management. Another common requirement is specifying a higher security deposit or adding a qualified guarantor. These "conditionally approved" residents should be rewarded for good performance; if they make timely rent payments for a certain period, their security deposit is reduced or their "probationary" status is removed.

Security deposit alternatives are also becoming more common and can represent a strong selling point for a community. One such product is a surety bond, which can be offered to applicants of certain risk levels. With a surety bond, the new resident pays a non-refundable fee in addition to, or instead of, a full security deposit. This fee provides a certain amount of money that is "pooled" and can be applied toward the apartment owner's loss reimbursement. Buying the bond reduces move-in costs for the resident and reduces overall exposure to the apartment owner.

"Surety bonds can be a useful tool in ensuring a buffer for the renting community in these cases," said Mike Beirne, Senior Vice President, The Kamson Corporation, Englewood Cliffs, N.J. "If we are to be an affordable alternative housing solution for many Americans, it isn't just the credit score but the credit history in total that matters."

Another key to implementing a successful program for high-risk applicants such as homeowners with mortgage defaults is to ensure that the forms related to the lease transaction are built into the renting procedure. Without proper document control, special renter programs might not be applied consistently or as intended. What's more, inconsistencies in the leasing process can lead to problems with Fair Housing--policies should be automated and carefully implemented. For example, federal laws mandate that a community manager supply an "Adverse Action Notice" to any applicant who is being accepted under a special program. With built-in forms generation, this notice can print automatically.

Integrated leasing forms, which should incorporate specialized rental program contracts that populate with data from the applicant screening process, protects communities by limiting unauthorized overrides of policies. Work with the resident screening and lease provider to limit the ability of employees within the organization to approve "conditional" applicants with special situations like mortgage defaults. If managers use Web-based providers, they can control policies in a central office to ensure timely conformity at all communities.

By creating a review process for certain applicant types, managers can increase occupancy without lowering their standards or diluting their overall resident quality. Adopt different permission levels for employees within the resident screening system so only users with special access can review and approve leases for applicants that fall in a certain category. Many management companies leave this responsibility to regional managers. Others designate an employee in their central office with this authority.

Take care to document and date any special rental programs, and the specific scenarios that qualify applicants for them. Fair Housing requirements mandate that all applicants be treated consistently; the policies should make clear how managers handle "conditional" cases.

Tips for Capitalizing on 'Born-Again Renters'

Case By Case: Identify mortgage defaults on a case-by-case basis with an "review" process; a credit score alone is useless to determine the details of default.

Layers of Access: Add layers of access to the resident selection process. Designate employees to review flagged accounts.

Conditional Approval: Develop "conditional approval" programs that incentivize good behavior but are carefully monitored.

Built-In Forms: Use built-in form generation to ensure consistent application of policies and compliance with "adverse action."

Marketing Know-How: Market the programs to appeal to former homeowners. The flexibility and other benefits of renting should not be undervalued.

Alternative Suggestions: Consider alternative programs such as collecting a larger deposit, requiring guarantors or offering surety bonds. Policy rules should be automated as part of the screening process.

Mortgage Meltdown At A Glance

The News: The mortgage meltdown presents an opportunity for apartment managers to welcome back former customers, but they should do so with a careful and thoughtful approach or they risk a meltdown of their own.

The Background: Lax lending standards helped to fuel an overheated housing market, which lured many consumers into houses they couldn't afford. The "sub-prime" lending market is being hit especially hard; some homeowners who received tricky loans during the housing boom now are seeing their monthly payments skyrocket while their low introductory rates disappear. And some won't be able to refinance into loans with easier terms.

What's Next: By re-examining their screening processes, implementing "conditional" approvals and considering security deposit alternative programs, apartment owners can lower their risks while capitalizing on this influx of renters.

Jake Harrington is Director of Business Development for OnSite.com. He can be reached at 650/934-4150. NAA's Director of Communications Paul R. Bergeron III contributed to this article.