Shared appreciation mortgage
From Wikipedia, the free encyclopedia
A shared appreciation mortgage 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.
[edit] 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.
[edit] 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 appreicated 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.
