New idea: Trading shared appreciation for principal reductionsby Peter Miller
Since the mortgage meltdown began, lenders have done everything possible to avoid the principal reduction. Such a position is reasonable and well-founded since most FHA, VA and conventional mortgages are loans which were in no way tricky or unfair to borrowers.
But a solution, or compromise if you will, has been proposed. It’s a way for Fannie and Freddie to prevent foreclosures and “protect taxpayers by combining principal reductions with ‘shared appreciation.’”
Trading a principal reduction for shared appreciation
The Center for American Progress suggests that lenders ought to accept small principal reductions–of say, 5 percent or 10 percent–in exchange for some of the appreciation if home values rise. We have seen this kind of thinking before, it’s called a shared appreciation mortgage (SAM).
This is not a bad idea—it allows lenders to trade something for a principal reduction as opposed to simply making a gift. The benefit for borrowers is simple–less principal means smaller monthly bills, and that’s something any household would welcome.
“We propose a pilot program,” said the Center for American Progress, “that reduces principal — often by as little as 5 percent or 10 percent — without creating skewed incentives for borrowers. Through so-called ’shared appreciation’ modifications, Fannie or Freddie agrees to write down a portion of the principal on deeply underwater loans in exchange for a portion of the future appreciation on the home. The borrower has a reason to keep paying, while the lender benefits when home prices eventually stabilize and rebound.”
The catch is that we’ve seen SAMs before. They’re actually common in countries and in economic systems which reject the payment of interest. In such situations, the party supplying the funds is more of a partner than a lender. If the value of the property goes up, both parties share in the benefit. If the value goes down, both share in the losses. There are no concerns about mortgage amortization in the usual sense.
In this country, the history of SAMs has been mixed.
In 2008, the government allowed the FHA to insure up to $300 billion in new funding under the Hope for Homeowners (H4H) program. Part of the original plan was that the FHA would get both insurance premiums as well as a 50 percent interest in a property’s appreciation. The program had a lot of requirements and the shared appreciation element was eventually dropped. Still, H4H hasn’t gone very far–there have been just two loans refinanced under the program thus far in fiscal year 2012.
SAM was never popular
In the private sector, the shared appreciation concept has never been particularly popular. Part of the reason is that SAMs were not within the tax code until 1981. That was the year we passed the Black Lung Benefits Revenue Act (Pub. L. 97-119), a measure which said that both owner occupants and outside investors could have an equity interest in the same property if both could get write offs.
In 2010, there was an equity sharing proposal but the idea has not gained much traction.
Not a bad idea
It will be interesting to see what federal regulators as well as the lending community thinks about the idea from the Center for American Progress. It’s not a bad idea. It’s certainly better than a foreclosure or the pain suffered by homeowners in the big losses which lenders must write off. Given the options which are out there, shared appreciation is not a bad concept–and given that many local markets continue to suffer with stagnating home prices, maybe it’s worth a try.