The latest addition to the nontraditional real estate financing arsenal -- dubbed the "SAM" loan by its federal agency originators -- could be just what furnished first-time home buyers have been waiting for. It could also turn out to be a time bomb ticking away for the same buyers and their banks.
The Federal Home Loan Bank Board, which regulates many of the nation's largest volume mortgage lenders, proposed the "shared appreciation mortgage" last week. Unlike the home loans that consumers have used for decades, federally sanctioned SAM loans would cut lenders in on homeowners' profits at resale, in exchange for a discounted mortgage interest rate.
Instead of a $50,000 standard home loan from your neighborhood savings and loan or savings bank at 13 percent, for example, you could get a $50,000 "SAM" at, say, 9 1/2 percent.
The difference in monthly payments at the lower rate would be very attractive ($420 per month versus $553 a month). And the lower payments required would greatly expand the pool of potential home buyers in every market of the United States.
A conventional $50,000 mortgage at 13 percent for 30 years requires a household income of about $31,000; the same size SAM loan, however, would require a $24,000 annual income -- putting a house or condominium within reach of individuals and working couples currently frozen out by double-digit interest rates.
The quid pro quo for the 9 1/2 percent discounted rate would be the buyers' agreement in advance to share up to 40 percent of their eventual capital gains on the house; with the S & L or bank. If a house doubled in value from $75,000 to $150,000, the S & L could stand to get up to 40 percent of the home buyers' gain. If the house didn't gain at all, or declined in value, the S & L would get nothing.
The lender and the buyers would set a limit of no more than 10 years for their "split"; if the buyers hadn't sold or refinanced their home prior to that date, they'd have to do so at the 10-year mark. The buyers would be guaranteed long-term refinancing at prevailing market rates by their lender, and thus be able to "cash out" their gains without actually having to sell or vacate their property.
The bank board concedes that SAMs "aren't likely to be anyone's first choice for financing." The agency believes, though, that in an economic climate like today's -- with rates back up to the 14 percent level in many areas and the cost of housing rising rapidly -- some form of profit-sharing is the only way to keep the homeownership door open for newcomers. If lenders are going to subsidize rates down to affordable levels, they're not going to do it for free. They want a piece of the inflationary action in real estate.
But will the drawbacks of the SAM home loan really be worth it for the home buyers and lenders who sign up for them?
Consider some of the risks for consumers who buy their first home with a SAM:
The monthly subsidy of $100-$150 inherent in a discounted rate loan could later end up costing buyers thousands of dollars in valuable capital gains they had to hand over to their financier -- particularly if the buyers picked a home in a rapidly appreciating neighborhood. Lenders' gains on their monthly "investments" could be staggering.
Since the bank board's rule would allow lenders and buyers to "negotiate" the amounts of rate discounts, the time limits for automatic profit splits, and the size of the lender's share of the profits, it's likely that consumers would be at a big disadvantage. Negotiations between financial professionals on one side of the table and amateurs on the other rarely produce results more favorable to the amateurs.
The cost of improvements to a house made over the years by the buyers would be subtracted from the "profits." But the extra resale value added by shrewd improvements above and beyond and their actual cost -- praticularly new kitchens, room additions and bathrooms -- would have to be split between lender and owner.
Once the lender "cashed out" and took his share of the profits, the home buyer's monthly costs could zoom. The discounted rate would be gone. The buyers refinanced debt would carry the prevailing market rate (which could well be 15 or 16 percent in the mid-1980's), and their monthly payments would jump by 75 or 80 percent overnight. That, in turn, could push the buyers into default and even foreclosure.
Lenders might not like SAMs overly much either. They'd be cutting current interest rate income -- never a favorite idea among bankers -- for the uncertainty of a large gain down the road from inflating real estate values.
But what if properties didn't inflate quite as fast as lenders anticipated? What if appreciation dropped from the double-digits back to the 5 and 6 percent range -- which is entirely possible in the coming decade. SAM lenders soon would be in financial trouble on their cut-rate loans. Having switched sides in the fight against inflation, they'd be double losers if inflation abated.