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Shared Appreciation Mortgages: Coming Back

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By : David Reinholtz    99 or more times read
If you’re a keen follower of those endless hearings that are conducted in the vast oak-paneled rooms of the United States Senate, you might have heard mention of a September 14, 2011 session held by the Housing, Transportation, and Community Development Subcommittee on Banking, Housing, and Urban Affairs. It was chaired by US Senator Robert Menendez (D, NJ) along with Ranking Member Jim DeMint (R, SC), and the topic was “New Ideas for Restructuring and Refinancing Mortgage Loans.”

Among the witnesses was Marcia J. Griffin, President and Founder of HomeFree-USA, a non-profit homeowners’ advocacy group. Among other things, she stated that the US ought to prioritize the development of the Shared Appreciation Mortgage (SAM) as a way to achieve equitable and broad-based refinancing of troubled home loans.

So what is a SAM? They are not currently offered by any major US loan originator, but should they be?

The Basics of SAM

The name of the product is self-explanatory. The SAM was first introduced in the early 1980s during a period of high interest rates that made qualifying for a mortgage a challenge for many prospective homebuyers. The concept was a simple tradeoff: the lender would offer the borrower a fixed rate, fixed term loan that was one or two points lower than what the borrower would normally qualify for. The short-term loss to the lender would be repaid from a share of the property’s appreciated value when the owner refinanced, moved (paying off the loan in the process), or otherwise terminated the loan.

The amount of appreciation due the lender could vary from 20% to as high as 50%. The bigger the share, the lower the rate offered to the borrower. For example, if a current 30-year standard fixed rate mortgage were 5%, a SAM with 25% appreciation assigned to the lender might carry a 4% rate. For a SAM with 50% appreciation assigned to the lender, the rate might be three percent.

Here’s an example. Say the borrower takes out a discounted SAM on a house valued at $200,000. After five years, the home has appreciated by $10,000 and the owner decides to sell. In a 50% revenue-sharing arrangement, the borrower would owe the lender half that ($5,000) plus the remaining unpaid balance of the loan.

If the house depreciated in value over the five-year period, when the house is sold the lender gets only the unpaid balance remaining on the loan, and nothing more. The lender has in effect given the borrower a regular mortgage at a discounted rate.

The trick with SAMs is that you’ve got multiple variables that can affect the profitability of the deal. They include changes in interest rates, changes in the overall real estate market, and changes to the property itself. You’re banking on the accuracy of real estate forecasts many years into the future. You don’t need to be a rocket scientist to see that in hindsight, just about any lender agreeing to a 30-year SAM on a residential property in 2007 would have quickly regretted the decision as housing prices plummeted.

When SAMs were introduced in the 1980s, in the United States the concept never caught on because adjustable rate mortgages (ARMs), with both a lower initial rate and the potential for the rate to go even lower, proved more attractive to consumers than any fixed rate mortgage. The SAM, like other specialty products, faded from view. Today, some are suggesting that it’s time to consider the SAM again.

The Fine Points of SAM

Because of their dependence on a set of variables, SAMs have evolved with various features that are designed to inhibit profit taking and deception, primarily on the part of the borrower.

An opportunistic borrower might be tempted to take a SAM for a while and then refinance to avoid sharing the appreciation, but SAMs often have a prepayment penalty or anti-refinancing clause to keep consumers from doing that. Often, during the first three years of the loan if the borrower prepays more than 20% of the outstanding balance, there’s a penalty assessed based on either the amount of the prepayment or a chunk of interest. These provisions are not triggered by a sale of the property.

One key issue, of course, is the definition of “appreciation.” Appreciation comes from two sources: improvements in the real estate market, and physical improvements made to the property. Market shifts cannot be helped. But from the homeowner’s point of view, the cost of making home improvements may be a problem. If you spend $20,000 on a new bathroom, that new bath will increase the value of your home, which is normally a good thing because when you sell your home, you’ll get it all back. But what if you had signed a contract with your lender promising to fork over 50% of your home’s appreciation? Suddenly your new bathroom is now going to cost you $30,000.

In such cases, neither lender nor borrower wants there to be any impediment to improvements that would enhance the value of the property. Consequently, SAM loan documents state that a “Qualified Major Home Improvement” (QMHI) is excluded from the calculation of appreciation. A QMHI is any “substantial” kitchen or bath modernization; a project that increases the living area of the home; new decks, porches, patios, or garages; and paving a previously unpaved driveway. In addition, the project must be completed within six months after you’ve started it, and the total cost of the project needs to exceed either $10,000 or 6% of the original value (or adjusted value) of the home.

How can the homeowner ensure that the property is valued correctly? A QMHI needs to be clearly defined and then the “basis value” of the house adjusted upwards. To do this, the homeowner has the property appraised. Then the homeowner builds the new garage or installs the bathroom. The cost is $20,000. As soon as the work is complete the property is appraised again, and the new appraisal should match the cost of the upgrade. This should make it a QMHI, triggering an adjustment of the basis value.

Are SAMs the answer for today’s struggling mortgage market? Lenders might jump on board if there were a widespread belief that prices will sharply rebound. If the market stays in the doldrums, SAMs will not be attractive to lenders. Lenders are watching the marketplace and Washington to see if the SAM is on the way back.
David Reinholtz is a professional Mortgage expert in Real Estate Industry. David is also a sales and marketing expert and trains professionals in every career field. David has personally trained tens of thousands of loan officers, mortgage brokers, real estate agents and individuals through The Close More University Seminar Series, Classes, Correspondence and On Line Learning, and countless private engagements and training events throughout the country.

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