A mortgage broker who recently began to offer shared-equity mortgages -- where the borrower gives up a share of future appreciation in exchange for a lower interest rate from the lender -- says there has been "phenomenal acceptance" of them in the District.
Albert D. Bryant, assistant vice president of Advance Mortgage Co., says that in the 45 days since the company first introduced its "appreciation participation mortgage" it has exhausted its initial loan budget of $1 million. p
Advance has made commitments for seven loans, including two to first-time buyers. Bryant said the company had applications from 20 or 30 persons in the District and inquiries from 300 to 400 in the suburbs. A majority of the applicants wanted financing for expensive houses -- in reality, "more house than they could otherwise afford," Bryant said.
The mortgage firm requires a 20 percent down payment and offers loans up to $150,000 for 30 years. Advance asks for a one-third share of the equity in exchange for a mortgage with interest rates one-third below market rates.
The firm is the only lender here offering shared-equity mortgages. Advance, the country's fourth-largest mortgage company, initiated the plan last summer. It is now in the process of selling its first $10 million in loans to a savings and loan in Florida, which is buying them as an investment.
The Federal Home Loan Bank Board has proposed that savings and loan associations themselves be allowed to offer what it calls shared appreciation mortgages -- SAMs for short. Mortgage bankers like Advance do not require regulatory permission to offer them because they are considered conventional loans.
Advance can offer the loans only in the District because Maryland and Virginia laws prohibit loans involving deferred interest. Bryant said Advance's lawyers have advised that because treatment of the lender's one-third share as deferred interest makes it impossible to determine the true mortgage interest rate at the outset, such contracts would violate truth-in-lending statutes.
Bryant said Advance hopes to persuade key legislators in Maryland to exempt shared-equity mortgages.
Meanwhile, the company plans to lend more money on a shared equity basis in the District as soon as additional funds become available, probably early next year, Bryant said.
The shared-equity mortgage has been hailed as one method that allows first-time buyers to enter the market.Yet the idea of giving up any future equity in a house -- often the owner's only hedge against inflation -- is controversial because it runs against a long tradition. Moreover, there is a question as to whether it is a good deal financially for the buyer.
Bank board calculations made at the time SAM was proposed showed that the greater the appreciation and the longer the house was held, the more the owner theoretically would lose at sale time.
For example, an owner who has a one-third share agreement with a lender would come out about even on the sale of a $75,000 house after two years, assuming the house appreciates by 10 percent a year. (The borrower would have saved $4,800 in interest costs, compared with the lender's after-sale share of $5,250.)
However, if the property were held 10 years, the lender would earn more on the deal than the borrower could save in interest; the borrower would have a net "loss" of $4,889 -- that is, the differences between what the borrower would have saved on interest costs and what he had to pay the lender works to his disfavor. At 14 percent appreciation, the "loss" would be $43,680 after 10 years.
Shepherd Moore, an employe of CACI Inc.-Federal, a Rosslyn computer software firm, took it upon himself to do some SAM calculations. Moore, who has a background in econometrics, contends that when taxes are figured into the equation -- something the bank board does not show -- the homeower actually gains by using a shared-equity arrangement.
Central to this argument is the treatment of the lender's share as deferred interest instead of capital gains for tax purposes. If the one-third share at sale is treated as the one-third off on the interest rate the buyer received at the outset, the amount is entirely deductible.
The Internal Revenue Service acknowledges that it has received many calls about this but has not yet been asked for a private ruling as to whether the lender's share is deferred interest of capital gains for tax purposes. If the one-third share at sale is treated as the one-third off on the interest rate the buyer received at the outset, the amount is entirely deductible.
The Internaal Revenue Service acknowledges that it has received many calls about this but has not yet been asked for a private ruling as to whether the lender's share is deferred interest or capital gains.
To illustrate the advantages of deferred interest, Moore has calculated how a shared-equity mortgage works for a borrower in the 33 percent tax bracket. By striking a one-third/one-third deal with the lender, the buyer can afford a $97,500 house at 9 percent instead of a $75,000 house at 13 percent with the same cash outflow: a $15,000 down payment and monthly payment of $663.72. But the buyer's standard of living is improved immediately by virtue of being able to afford a better house for the same amount of money.
The homeowner is still ahead when it comes time to sell, according to Moore. In 10 years the $75,000 house will be worth $194,530, assuming 10 percent annual appreciation. Subtracting the remainder due on the mortgage, $56,652, the owner nets $137,878.
The $97,500 house, on the other hand, is sold for $252,890 after a decade of 10 percent annual appreciation. The lender's one-third share of the appreciation amounts to $51,797, but the owner has saved $17,093 in taxes on that one-third appreciation by deducting it as deferred interest. Subtracting the balance due on the mortgage, $73,780, his or her net gain is $144,406.
Using the same two examples, Moore has calculated that the shared-equity participant would be ahead of the person who borrowed at market rates by $7,580 ($254,345 vs. $246,765) if the houses appreciated by 15 percent annually over a decade. At 10 percent appreciation for five years, the difference is $2,684. At 10 percent appreciation for two years, the shared-equity borrower is ahead by $956, according to Moore.
Moore has not factored in the annual nterest deduction on the mortgage, which obviously would be larger for the person paying 13 percent than for the one paying 9 percent. For example, in the first case cited, the $6,528 ($144,406-$137,878) advantage enjoyed by the SAM participant would be reduced by $1,772 when the larger amount of annual interest paid by the traditional borrower is deducted.
Moore says in none of the examples given would the difference in annual interest deduction change the fact that SAM is a better deal over the long run.