I have spoken with a few people who completed mortgage modifications on their houses and were given a shared appreciation mortgage as a way to lower the principal balance of the mortgage.
The lenders did not really explain what a shared appreciation mortgage was, so I read the loan documents and investigated and learnt the following.
WHAT IS A SHARED APPRECIATION MORTGAGE?
A shared appreciation mortgage is different from a regular mortgage because the borrower will pay a portion of the appreciation of the house to the lender (and the remaining principal balance) when the borrower sells the house.
With a normal mortgage, the borrower pays the lender the remaining principal balance of the loan, and no more. With a shared appreciation mortgage, the borrower pays the remaining principal AND a portion of the appreciation of the house.
Appreciation of a house is when the house gains value.
For example:
- If you buy a house for $150,000 and sell it years later for $160,000, then the house appreciated $10,000
- If you had a shared appreciation mortgage, then you would have to pay a percentage of this $10,000 to the lender
Sometimes lenders will offer a lower interest rate to a borrower (which means lower payments) in exchange for a shared appreciation clause.
WHY WOULD I WANT A SHARED APPRECIATION MORTGAGE?
Shared appreciation mortgages are uncommon for American consumers and are not generally advertised or offered.
There are, however, situations where they make sense.
- They can be useful to lower the borrower’s monthly mortgage payment because lenders generally give a lower interest rate since they will be getting more money when the house is sold
Lenders and mortgage servicers have also been giving shared appreciation mortgages to people who complete mortgage modifications.
Shared appreciation mortgages seem like a good idea because:
- The post-modification shared appreciation mortgages usually lower the principal balance to the current value of the house, and have a phasing-out shared appreciation clause
- It stops the house from being underwater (being worth less than is owed on it) because the principal balance gets lowered to the value of the house, established by an appraisal
- It lowers the monthly payments because it means that the borrower is paying interest on a smaller principal balance
What is a phased-out shared appreciation clause?
The portion of the original loan that is covered by the shared appreciation clause is usually called the “deferred principal” on the statement.
This means that the borrower pays a percentage of house appreciation only if they sell within the first few years.
- The loans like this which I have seen have given 25% of the appreciation to the lender if the borrower sells within five years of the modification
A smart borrower would keep the house for those five years, and then sell later, because it would allow the borrower to keep all of the appreciation on the house.
WHY WOULD A BANK GIVE A SHARED APPRECIATION MORTGAGE?
Banks have two possible reasons to make shared appreciation mortgages.
1. Profit
The first reason is that if the property is in a place that is likely to increase in value, such as an up and coming neighborhood, then the bank might make more from appreciation than it would make from interest.
This strategy allows the bank to diversify its risk so that there is both an interest component to the income from the loan, and an appreciation component to that loan.
It is also possible that a bank might insert a shared appreciation clause into a loan without fully informing the borrower of it.
Since borrowers rarely read and understand their loan documents, such a strategy would be profitable for the lender.
2. Government mandated
The second reason a bank might make a shared appreciation mortgage is because the government mandated it.
In the wake of the housing crisis the US Federal Government negotiated several settlements with big mortgage lenders and passed new legislation requiring these banks to change existing mortgages.
Banks are required to reduce some principal balances, and shared appreciation mortgages are one way to lessen the losses from principal reductions.
WHAT TO DO NEXT
If you know that you’ve got a Shared Appreciation Mortgage, or have just discovered that you’ve got one, and are thinking about filing for Chapter 7 Bankruptcy or Chapter 13 Bankruptcy in Minnesota, then why not not speak to us now at 612.824.4357?
We’ll give you all the help and advice you need.
Alternatively, fill out our free Bankruptcy Evaluation Form to see if filing for Chapter 7 Bankruptcy or Chapter 13 Bankruptcy in Minnesota is right for you.
We’re looking forward to helping you.
