A Guide to Shared Appreciation Mortgages

While buying a home can often feel like an overwhelming process, from saving up for a down payment to navigating a seemingly endless trove of financial jargon, doing so is generally considered a smart investment. It allows you to build up some equity, and, despite fluctuations in the market, homes tend to appreciate which can put money in your pocket.

According to a 2018 Home Affordability Report, however, prices are climbing in the U.S. and are at their least affordable since 2008. So how can families tap into what’s long been considered an essential piece of the American Dream—buying a home?

This is where a shared appreciation mortgage can save the day. A buyer gets a loan that can help mitigate the costs of monthly payments by securing a below-market interest rate without having to pay anything back until the time comes to sell the home. Or, a shared appreciation mortgage can even allow current homeowners the ability to tap into their home’s equity before they even sell.

So what’s the catch?

In this article, we’re going to review everything you need to know about a shared appreciation mortgage—what it is, how it works, the pros and cons, and more so you can take the next step in buying your dream home.

Couple Investing Getting Key

Shared Appreciation Mortgages 101

When financing a home, most lenders will offer a variety of financial services and products which can be mutually beneficial for the lender and buyer—that is, both parties get something out of the deal. So what is a shared appreciation mortgage and what does it offer?

A shared appreciation mortgage essentially allows the buyer to obtain a below-market interest rate which will lower the cost on their monthly payments. If you’ve never purchased a home before, the interest rate lenders offer depend greatly on factors like credit score, credit history, income, and debt-to-income ratio. Basically, they determine the interest rate by looking at your full financial profile.

If this profile is lacking or sub-par in any of these areas, you might be looking at a higher interest rate, and therefore, higher monthly payments.

A shared appreciation mortgage shakes up how traditional mortgage loans work by allowing buyers the option of benefitting from a low-interest rate in exchange for sharing the home’s value as it appreciates over time. When it comes time to sell your home, your lender gets a piece of the profit.

How Does it Work if You Already Own a Home?

If you already own a home and want to access it’s equity, you can still benefit from a shared appreciation mortgage, which can be a great alternative to a Home Equity Line of Credit (HELOC).

This allows homeowners as well as home buyers the opportunity to access their home equity now in exchange for a piece of their future home appreciation. So when it comes time to sell, the investor will receive a share of the home’s value so you don’t have to worry about added debt, interest, or monthly payments. How much equity you can unlock depends on the lender and terms of the agreement.

An Example of How a Shared Appreciation Mortgage Works

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First, let’s look at how a typical mortgage setup looks like if you’re in the market for a new home. When you buy a home, your lender—whether it’s a bank, credit union, or other third-party lenders—will offer you an interest rate on the loan. Let’s say, your loan is for $200,000. Fortunately, your home has appreciated in value over the years and has now sold for $250,000. You get to pocket that $50,000 profit.

With a shared appreciation mortgage, on the other hand, you have to share that profit with your lender, with the exact amount specified in advance. Looking at the same example above, let’s say your lender agreed to give you a discounted interest rate to lower your monthly payments in exchange for 10% of the profit of your home. So in this case, you would be handing over $5,000 to your lender when you sell your home.

After paying off the principal amount (the $200,000 borrowed), this arrangement still puts $45,000 in your pocket, making it a financially sound option for those looking for some relief on their monthly mortgage payments.

What if you never sell the home?

Whether you’re happy to stay put in your home or simply want to put off having to pay your lender back for a few more years while coasting on your low monthly mortgage payment, keep in mind that there is a contingency in your contract based on this scenario.

While the agreement terms vary from lender to lender, you might have something in the contract that specifies if your home is not sold in 10 years, for example, they will conduct an appraisal of the home to evaluate the home’s current worth and demand 25% of the appreciation, which you will be responsible for owing at that point in time.

Again, these numbers vary, but it’s important to read the fine print and see what they are to ensure you’re comfortable with the terms.

What if the home does not appreciate or sells at a loss?

Historically, homes to tend to appreciate in value, but what if it doesn’t? While the answer might seem obvious—you shouldn’t have to pay anything to the lender in the case that the home does not appreciate!—you might still be on the hook, which is why it’s very important to include this verbiage in the contract rather than making assumptions.

If you’re worried your home might not appreciate in value, be sure the contract explicitly states that you have no obligation to pay anything to the lender, otherwise, you may be stuck owing something in the end.

The Pros of a Shared Appreciation Mortgage

  • A home appreciation mortgage is a great way to earn a lower interest rate on a mortgage which can ease the financial burden of monthly payments.
  • Monthly payments are significantly less, since they only include insurance, property taxes, and maintenance.
  • Current homeowners can tap into their home’s equity before they sell, putting cash in their pockets now.
  • The terms and conditions of a shared appreciation mortgage are not always set in stone by the lender, and can sometimes be negotiated, especially with the help of a lawyer.
  • If your home does not appreciate in value or if you take a loss when it comes time to sell, you may not be obligated to pay anything to your lender, depending on the loan agreement.
  • Makes qualifying for the loan easier, since the house is a form of collateral.

The Cons of a Shared Appreciation Mortgage

  • You are obligated to share the profits of your home with the lender.
  • If property values have risen and you want to buy a bigger home, having to shell out a portion of your home’s value can hurt.
  • If you decide to stay in your home for a longer period of time, you will be subject to a home appraisal conducted by your lender, who will then demand a percentage of the appraised value.
  • A shared appreciation mortgage often comes with an origination fee (which is generally between 2-5%).

Who Benefits from a Shared Appreciation Mortgage?

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People are often wary of the different financial products and services out there, and they needn’t be. After all, while you can rest assured that a reputable financial institution is probably not trying to scam you, they do need to make money through some form of mutually beneficial arrangement, which can be incredibly beneficial to some people, but not everyone.

This amalgam of products exist because no two financial profiles are the same. We all come from different backgrounds with varying financial situations that require unique solutions. In short, one size does not fit all. So when considering a shared appreciation mortgage, who stands to benefit most?

Limited Cash Flow

For those who have a limited cash flow and might not be able to afford hefty monthly mortgage payments, a shared appreciation mortgage is certainly worth considering. This type of loan offers below-market interest rates and access to the home’s equity for both homeowners and home buyers. Additionally, homeowners can receive a percentage of their home’s value in cash to spend as they please—be it new home renovations, investments, or a vacation.

Home Investors

For home investors or house flippers, a shared appreciation mortgage is useful. The criteria for qualifying is fairly simple and buyers can cash out quickly and easily. If an investor purchases a home with the intention of fixing it up and then selling it at a profit, normally the investment is contingent upon the house selling. With a shared appreciation mortgage, however, investors can trade in a piece of the future gains in exchange for immediate access to that equity.

Less Stable Incomes

For those who are self-employed or have less stable incomes and cannot meet the requirements needed for more traditional equity services, a shared appreciation mortgage can be the next best thing. In this case, your home itself serves as a form of collateral for the mortgage loan and monthly payments are not required, so lenders are not as concerned with a borrower’s ability to repay it since the home value protects their interests.

The Application Process

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Once you’re convinced that a shared appreciation mortgage is the right financial tool for you, what does the application process look like and what will you be needing?

Fortunately, applying for a shared appreciation mortgage is fairly straightforward for both homeowners and home buyers. The first step is to research and find the right lender who offers this product, and discuss with them the terms and conditions involved, such as what interest rate they offer, what the fees are, how much equity you can access, and what happens if your home does not appreciate. These are all important considerations, so be sure to get the answers you need before moving forward with a lender.

While you can certainly navigate the process alone, it might help to involve a tax attorney to help review the terms of the loan.

The next step is to put in your loan application once you’ve approved the terms of the agreement with your lender. Some documents that are likely required include the following:

  • Proof of income and employment, such as W-2 forms and pay stubs
  • Bank statements for assets that are being used to qualify
  • Retirement account statements, such as those from IRAs or CDs
  • A list of debt payments, such as student loans and credit cards

Bottom Line

While a shared appreciation mortgage isn’t the financial solution for everyone, overall, it can be a great product for homeowners and buyers who could use some relief on their monthly payments.

A shared appreciation mortgage can put you in the home of your dreams and bring some much needed financial relief—the key is to understand what’s involved and the what the lender’s terms and conditions are, which can vary.

Now that you have a greater understanding of how these types of loans work and what’s involved, the next step is finding the right lender and establishing the best terms for your agreement.