Is This Shared Appreciation Mortgage a Good Deal?
Column Delivered October 22, 2001
“The city of Burbank has a Mortgage Assistance Program that offers home buyers a 30-year second mortgage loan, with zero interest and no payments for the first 5 years. After 5 years, the second must be repaid over 25 years at 5%. In exchange, the city receives a share of the appreciation in the house when it is sold. The share is equal to the amount of the second mortgage as a percent of the sale price. For example, if the house is purchased for $250,000 (the maximum allowed) and the buyer takes the maximum second mortgage of $35,000, the city would take 14% of the difference between $250,000 and the price at which the house is sold. The buyer must put 3% down. Is this a good deal for home buyers?”
The Burbank program is similar to programs offered by a number of other cities in California and Oregon. They are a type of “shared appreciation mortgage” or SAM, similar to SAMs offered by private lenders. Where the private programs offer an interest rate concession on the first mortgage, the Burbank program offers an interest rate concession on a second mortgage.
It’s a pretty good deal, although the $250,000 price ceiling limits the number of households that can use the program. There are also income limits, currently $62,500 for a household with 4 or more persons.
The second mortgage under the Burbank program has two advantages. The terms are highly favorable – especially the 5-years of zero interest. In addition, the second mortgage reduces the mortgage insurance premium on the first mortgage.
Mortgage insurance premiums are based on the ratio of the first mortgage loan amount to property value. A standard 30-year fixed-rate mortgage with 3% down has a loan-to-value ratio of 97%, and the mortgage insurance premium is about .9%.
Under the Burbank program, assuming 3% down and a second mortgage equal to 7% of price, the loan-to-value ratio is 90%, and the mortgage insurance premium is about .4%. If the second mortgage is 12% of value, the loan-to-vale ratio is 85%, and the premium is about .3%.
I developed a spreadsheet that compares the total cost to the borrower under the Burbank program, year by year, with the costs under conventional financing. These comparisons led to the following conclusions:
1. In most cases, only second mortgages of 7% or 12% of price are worth considering. A second for 14% of price, for example, requires the same mortgage insurance premium as a 12%, but the borrower must give up more appreciation.
2. Borrowers who expect to be in their house a relatively short time do better than those who expect to stay indefinitely. This is partly because of the 5 years of zero interest on the second mortgage. In addition, the number of dollars lost through the shared appreciation grows over time.
3. Under the Burbank plan, monthly payments are 10-12% below those on conventional financing for 5 years. Borrowers who can invest the monthly payment savings at high yields will do better than borrowers who spend the savings or invest them at low yields.
4. Borrowers who expect modest appreciation will do better under the Burbank plan than those who expect rapid appreciation. However, to wipe out the advantage of the Burbank program, appreciation usually has to exceed 5-6% a year.
Here are a few concrete examples. They assume a $250,000 house, and that the alternative to the Burbank program is a $242,500 conventional 30-year loan at 7.5%. I converted the mortgage insurance premium advantage of the Burbank program into interest rate equivalents. The rates are 7% on a second mortgage for 12% of price, and 7.1% for a second of 7% of price.
Smith takes a second for 7% of price, assumes 6% price appreciation, and 3% return on monthly payment savings. He saves money on the Burbank if he sells before 253 months. The maximum saving of $4718 is reached at 119 months.
Jones also assumes 6% price appreciation and 3% return on savings, but he takes a second for 12% of price. He saves money on the Burbank if he sells before 186 months, and the point of maximum saving is also earlier at 61 months. The maximum saving is larger, however, at $5390.
Peters also takes the 12% second but assumes 7.5% return on payment savings. If his house appreciates by 6% or less, his cost savings rise every month for 30 years.
Readers who would like an estimate that meets their situation can write me. But don’t ask for the spreadsheet, it is too user-unfriendly.
“The city of Burbank has a Mortgage Assistance Program that offers home buyers a 30-year second mortgage loan, with zero interest and no payments for the first 5 years. After 5 years, the second must be repaid over 25 years at 5%. In exchange, the city receives a share of the appreciation in the house when it is sold. The share is equal to the amount of the second mortgage as a percent of the sale price. For example, if the house is purchased for $250,000 (the maximum allowed) and the buyer takes the maximum second mortgage of $35,000, the city would take 14% of the difference between $250,000 and the price at which the house is sold. The buyer must put 3% down. Is this a good deal for home buyers?”
The Burbank program is similar to programs offered by a number of other cities in California and Oregon. They are a type of “shared appreciation mortgage” or SAM, similar to SAMs offered by private lenders. Where the private programs offer an interest rate concession on the first mortgage, the Burbank program offers an interest rate concession on a second mortgage.
It’s a pretty good deal, although the $250,000 price ceiling limits the number of households that can use the program. There are also income limits, currently $62,500 for a household with 4 or more persons.
The second mortgage under the Burbank program has two advantages. The terms are highly favorable – especially the 5-years of zero interest. In addition, the second mortgage reduces the mortgage insurance premium on the first mortgage.
Mortgage insurance premiums are based on the ratio of the first mortgage loan amount to property value. A standard 30-year fixed-rate mortgage with 3% down has a loan-to-value ratio of 97%, and the mortgage insurance premium is about .9%.
Under the Burbank program, assuming 3% down and a second mortgage equal to 7% of price, the loan-to-value ratio is 90%, and the mortgage insurance premium is about .4%. If the second mortgage is 12% of value, the loan-to-vale ratio is 85%, and the premium is about .3%.
I developed a spreadsheet that compares the total cost to the borrower under the Burbank program, year by year, with the costs under conventional financing. These comparisons led to the following conclusions:
1. In most cases, only second mortgages of 7% or 12% of price are worth considering. A second for 14% of price, for example, requires the same mortgage insurance premium as a 12%, but the borrower must give up more appreciation.
2. Borrowers who expect to be in their house a relatively short time do better than those who expect to stay indefinitely. This is partly because of the 5 years of zero interest on the second mortgage. In addition, the number of dollars lost through the shared appreciation grows over time.
3. Under the Burbank plan, monthly payments are 10-12% below those on conventional financing for 5 years. Borrowers who can invest the monthly payment savings at high yields will do better than borrowers who spend the savings or invest them at low yields.
4. Borrowers who expect modest appreciation will do better under the Burbank plan than those who expect rapid appreciation. However, to wipe out the advantage of the Burbank program, appreciation usually has to exceed 5-6% a year.
Here are a few concrete examples. They assume a $250,000 house, and that the alternative to the Burbank program is a $242,500 conventional 30-year loan at 7.5%. I converted the mortgage insurance premium advantage of the Burbank program into interest rate equivalents. The rates are 7% on a second mortgage for 12% of price, and 7.1% for a second of 7% of price.
Smith takes a second for 7% of price, assumes 6% price appreciation, and 3% return on monthly payment savings. He saves money on the Burbank if he sells before 253 months. The maximum saving of $4718 is reached at 119 months.
Jones also assumes 6% price appreciation and 3% return on savings, but he takes a second for 12% of price. He saves money on the Burbank if he sells before 186 months, and the point of maximum saving is also earlier at 61 months. The maximum saving is larger, however, at $5390.
Peters also takes the 12% second but assumes 7.5% return on payment savings. If his house appreciates by 6% or less, his cost savings rise every month for 30 years.
Readers who would like an estimate that meets their situation can write me. But don’t ask for the spreadsheet, it is too user-unfriendly.