Shared appreciation is an idea whose time may have come. Indeed, it may be the only way for the nation’s banks to avoid still-more losses, additional deficits that could total hundreds of billions of dollars.
What’s shared appreciation, how does it work and how can it help banks and borrowers? Let me explain:
For a long time there has been something called SAM financing, or shared appreciation mortgages. These are loans where the lender is an equity partner in the property. If the value goes up the lender comes out ahead. If the value goes down the lender has a loss. Importantly, if the value goes down the borrower’s liability to the lender does not grow, there can never be a deficiency judgment.
To this point SAMs have always been associated with financing to buy a property. But why not use SAMs when property values fall? In other words, why not refinance with a SAM — especially when the owner has financial troubles? That’s the essential question raised by New York’s Department of Financial Services (DFS).
The DFS proposal is aimed at the huge number of foreclosed properties which remain in REO (real estate owned) inventories. As of November 2013 there were 503,577 foreclosed homes held by lenders, according to RealtyTrac Vice President Daren Blomquist.
Vampire Real Estate
In many cases the foreclosed homes owned by lenders are “vampire” properties, a term coined by Blomquist, meaning foreclosed real estate where the borrowers still live in the property — rent free. In some areas such as Philadelphia, Las Vegas, Indianapolis, Jacksonville, St. Louis and Tampa it’s estimated that roughly a third of all foreclosures are actually vampire properties.
No less important, while the real estate marketplace has plainly improved large numbers of homeowners have financial troubles and could well be headed for foreclosure.
The New York proposal addresses this problem. In basic terms it would authorize lenders to convert existing loans into shared-appreciation mortgages.
Shared Appreciation Mortgages — Pros and Cons
The New York plan is aimed directly at failing mortgages. The huge attraction for lenders is that a failing mortgage could be instantly converted into an “asset” of some sort and thus kept off the books as a loss. In addition, the property would be occupied, thus holding down vandalism and maintenance costs, and the occupants would pay for taxes, insurance and the loan.
Borrowers will also like the proposal: First, they will have a roof over their heads. Second, over time they could actually profit as home values rise. Third, their credit standing could improve.
What’s not so clear is how the transactions will be treated for federal tax purposes. The Mortgage Forgiveness Tax Relief Act ended on New Year’s Eve and unless replaced it could mean big tax bills for borrowers when mortgages are not fully repaid. Borrowers should speak with a tax professional for specifics to determine how a shared appreciation conversion should be reported.
Shared Appreciation Mortgages — The Rules
However, New York is not allowing just any shared appreciation plan. It has carefully defined what’s allowed and what’s not:
- The property must be underwater.
- The property must be a prime residence — the program does not apply to investment real estate though properties with one-to-four units are allowed.
- The borrower is at least 90 days late and does not qualify for a loan modification.
- The borrower cannot be charged a modification fee, though the lender can charge the actual cost of an appraisal.
- The lender’s interest in the property is limited to the lesser of the principal reduction plus interest or 50 percent of the appreciation obtained from the sale of the home.
The proposal from New York state outlines a foreclosure-avoidance plan that could save big money for lenders, help homeowners avoid the auction block and protect neighborhoods against the falling home prices that can emerge after a flurry of foreclosures and short-sales. Given the alternatives, it’s easy to imagine a new surge in SAM financing.