Shared appreciation mortgage

A shared appreciation mortgage or SAM is a mortgage in which the lender agrees as part of the loan to accept some or all payment in the form of a share of the increase in value (the appreciation) of the property.

In the US

A shared appreciation mortgage is a mortgage in which the lender agrees to an interest rate lower than the prevailing market rate, in exchange for a share of the appreciated value of the collateral property. The share of the appreciated value is known as the "contingent interest", which is determined and due at the sale of the property or at the termination of the mortgage.

For instance, suppose the current prevailing interest rate is 6%, and the property was purchased for $500,000. The borrower puts down $100,000 and takes out a mortgage of $400,000 amortized over 30 years. The lender and the borrower agree to a lower interest rate of 5%, and to a contingent interest of 20% of appreciated value of the property. Because of the lower interest rate, the monthly payment is reduced from $2,398 to $2,147. However, this saving in monthly payments comes with a trade-off. Suppose the property is later sold for $700,000. Because of the agreement on the contingent interest, the borrower must pay the lender 20% of the profit, namely, $40,000.

By participating in the appreciation of the property, the lender takes an additional risk that is related to its value. Hence, whether this is a favorable trade-off depends on the conditions of the housing market. A shared appreciation mortgage differs from an equity-sharing agreement in that the principal of the loan is an unconditional obligation (to the extent collateralized by the property). Thus, if the property’s value decreases, the borrower would still owe whatever principal is outstanding, and if the borrowers sells the property for a loss, the contingent interest is simply zero.

Revenue Ruling 83-51 (1983) of the Internal Revenue Service specifies conditions under which the contingent interest in a shared appreciation mortgage may be considered tax-deductible mortgage interest. In particular, a shared appreciation mortgage must stipulate an unconditional obligation of payment of principal to avoid being recharacterized as an equity-sharing agreement, which may lead to different tax consequences. Because of the complexity of tax laws and terms tailored for individual situations, private, noncommercial mortgages involving shared appreciation should always be executed with the counsel of a real estate attorney.

Use in Real Estate Investment Financing (US)

In the real estate financing industry, a Shared Appreciation Mortgage (SAM) can be used as an "Alternative Financing" option for real property investments of all sizes, rather than being confined to the terms and conditions imposed upon most investors by traditional banks. A SAM is a perfect vehicle for pension funds such as an IRA when funding a SAM that is secured by real property. The taxable income may be deferred when using pension funds such as a standard Individual Retirement Account (IRA), 401(k), or expunged when funding is done using a Roth IRA, 401(solo) K Roth etc.

The SAM, when used as an 'Alternative Financing’ option, has a greater flexibility to be structured outside of the parameters imposed by a traditional banks terms and conditions when securing financing on investment real property. A benefit to a borrower in making use of a SAM would be to keep more of the borrowers own funds free to use in completion of a project. The bank, in many instances will require the borrower to place 6 - 9 months of cash reserves (i.e. the equivalent of the amount of the payment for the loan for that period of time) to be deposited in an account with the bank earning 1% - 2% while charging the borrower 3 -4 times that amount in interest for the loan. During the term of the loan, should the need for additional capital become necessary, the borrower cannot use any of the cash reserve funds held by the bank to facilitate paying for the completion of an on-going project such as the entitlement process for land development project or the completion for a rehab of an existing building. In many cases, this places an additional burden on the borrower as these funds are usually needed as additional working capital to complete a real estate project or keep the borrowers business doors open while completing the project.

Another benefit to a borrower is that he/she may elect to use a SAM that can be structured to allow for a higher loan to value (LTV) ratio than what a bank or institutional lender may allow. For instance, mostly lenders that provide land loans have a 50% - 60% LTV Ratio lending limit, whereas a SAM can be structured by the borrower to provide as high a LTV Ratio as is agreed upon between the SAM investors (lender) and the borrower. Other borrowers do not, for many reasons such as privacy, want to provide the bank with 2 -3 years personal tax returns and financial statement to the bank.

Another benefit to the investor/lender is that the SAMs flexibility includes the possibility that it can be structured to offer an investor not only a Basic Interest rate of return to be paid by the borrower which may be offered to the investor/lender at a lower or higher interest rate than what traditional lenders currently charge, while providing the investor/lender the potential of realizing additional Bonus or Contingent Interest by a participation in an agreed upon percentage of a real property’s net sale proceeds when sold to a third party buyer.

SAMs can be used in private offering or as a stand alone alternative Promissory Note which can be secured or non-secured by real property. When a borrower is creating a SAM as a private offering the borrower must be aware of the usury laws within the state that the SAM is prepared. Violating these usury laws can nullify any tax advantages to the investors such as pension funds if not structured correctly, thereby making all income a taxable event with the possibility of penalties. If an individual is anticipating using pension or other funds to invest in a SAM, they should always take it to a Tax Attorney or CPA to be reviewed and approved prior to their investment.

In the UK

A shared appreciation mortgage is a mortgage arranged as a form of equity release. The lender loans the borrower a capital sum in return for a share of the future increase in the growth of the property. The borrowers retain the right to live in the property until death.

Shared Appreciation Mortgages sold between 1996-1998 have not always turned out to be products beneficial to the borrowers who took them out. In the late 1990s, Barclays Bank and the Bank of Scotland [ [http://www.mortgagesexposed.com/Book_Contents/shared_appreciation_mortgages.htm www.mortgagesexposed.com] by Michael Kelly (retrieved 13 August 2007)] sold about 11,000 shared appreciation mortgages, targeting pensioners, just before the sharp rises in the property market. Customers could borrow the equivalent of 25% of the value of their property interest free. The banks gain from receiving 75% of the increase in value of the customer's property once it is sold.

The last ten years have seen property prices increase by 3 to 4 times. Many customers who took out a shared appreciation mortgages now find themselves trapped.

An example: a property valued at £100,000 in 1997 is now worth £400,000 (2007). The client took out a SAM of £25,000 (or 25% of the 1997 value). The contract stated that, upon sale or death, the banks could claim 75% (3 x 25%) of the difference in value plus the original loan (75% x £300,000 + £25,000 = £250,000). Therefore the bank will receive, upon sale, £250,000 (62.5% of the current value) and the client £150,000. The problem arises when the customer wants to sell up and move home. With only £150,000 to play with, even downgrading to a smaller property half the size of their current house would cost £200,000 and as such would be unaffordable.

Thus, in a market where house prices are rising in the long-term, this type of deal is usually detrimental to the customer [ [http://scotlandonsunday.scotsman.com/business.cfm?id=2061052005 Scotland on Sunday] The appreciation society forgets its elderly members (retrieved 13th Aug 2007)] . On the other hand, if a customer took out a SAM and house prices stayed steady or declined, the customer would effectively have a completely interest free loan with no downsides. On a 10 year mortgage of £100,000 at 6%, the customer would save £33,225 in mortgage repayments with no loss to the customer.

Many disgruntled SAM customers have got together to form the [http://www.samag.wanadoo.co.uk/index.html Shared Appreciation Mortgage Action Group] (SAMAG). They hope to find a legal settlement for "victims" of shared appreciation mortgages and are pursuing legal remedies.

References

See also

*Mortgages
*Equity release