The mortgage of the week bears the acronym SAM.
Like so many of its predecessors -- variable rate mortgage (VRM), renegotiable rate mortgage (RRM), adjustable rate mortgage (ARM), reverse annuity mortgage (RAM) and graduated payment mortgage (GPM) -- the shared appreciation mortgage, proposed this week by the Federal Home Loan Bank Board, is an alternative to the conventional fixed-payment home loan.
Unlike the many others conceived recently as remedies for soaring money costs, SAM involves apportioning the equity in a house rather than jiggling interest rates.
First introduced by Advance Mortgage Corp., the SAM concept offers the borrower a below-market interest rate. In exchange, the borrower agrees to pay the lender a specified share of the increased value of the house after a certain time.
The maximum percentage of equity the borrower could demand would be 40 percent, presumably in return for a 40 percent cut in the mortgage rate.
The loan has fixed rate payments calculated on a 30 or 40-year maturity schedule.
Appreciation would be based on the net sales price minus any improvements made by the homeowner.
The bank board proposes to make the payment due when the house is sold or after 10 years, whichever comes first. If the house is not sold, the current market value of the property would be determined by appraisal. After the payment, the lender is obliged to finance the house.
If the property does not appreciate, the lender receives only the principal and interest due on the loan. If the property depreciates, the lender does not share in the loss and still receives interest and principal.
With conventional fixed-rate mortgages, the lender absorbs the risk that money costs will rise higher than the interest rate on the loan, but the new alternative variable rate mortgages pass the risks to the borrower.
SAM, however, shares the risk between lender and borrower. Since this concept is being pushed by the industry, it is not difficult to understand who assumes the greater risk.
SAM benefits the borrower by reducing monthly mortgage payments to affordable size, especially in the case of a first-time buyer. In exchange, the borrower renounces a portion of his or her greatest hedge against inflation, increasing equity in a home. The lender, who is unlikely to offer a SAM in a neighborhood that is declining, runs little risk of the property not appreciating, given historical trends and predicted shortgages in future markets.
If the buyer can afford current market rate interest payments, SAM is probably not a good deal -- unless he or she plans to own the house only a short time. In such an event, what the buyer saves on interest payments could exceed the lender's share of the appreication.
The bank board worked out a series of assumptions on a $60,000 SAM loan at 9 percent -- one-third below a 13 percent market rate. The borrower saves $2,400 a year on interest payments.
If the $75,000 property appreciates at 10 percent a year, it will have a value of $90,750 in two years. After sale, the lender's one-third share of the net appreciation would amount to $5,250. At the same time, the borrower would have saved $4,800 in interest payments, so borrower and lender come out just about even. If the sale were made after six years, the lender would get $19,289 and the borrower would have saved $14,400, a net "loss" to the borrower of $4,889.
The borrower's "losses" mount as the average annual rate of increase in the value of the property rises. At 14 percent appreciation, the lender would get $29,874 after six years; the borrower would have saved $14,400, for a net "loss" of equity of $15,474. After 10 years, the "loss" would be $43,680.
The borrower's uncollected equity is not really quite the loss it would seem, since the borrower realizes his or her savings monthly. The lender also does not get his or her profit until years later. Also, the lender's rate of return on the loan will have decreased slightly as the principal is paid off.
There are as many variables possible in the equation as there are shifts in the rate of appreciation, the lender's share of it, the length of time the house is owned, and so on. The lender should provide a full disclosure statement for the borrower showing the variables. But in general, the borrower should realize that the higher the appreciation rate -- and Washington has a high average -- the lower the lender's contracted share should be to make the arrangement more equitable.
The public may send comments on the proposal to the bank board. the deadline for submitting them is Dec. 1.