A shared appreciation mortgage often abbreviated as "SAM" is a mortgage in which the purchaser of a home shared a percentage of the appreciation in the home's value with the lender. In return, the lender agrees to charge an interest rate that is lower than the prevailing market interest rate. The lender agrees to receive some or all of the repayment of the loan in the form of a share of the increase in value (the appreciation) of the property.
In the UK A shared appreciation mortgage is a mortgage arranged as a form of equity release. The lender loans the borrowers a capital sum in return for a share of the future increase in the value of the property. The borrowers retain the right to live in the property until death.
Shared appreciation mortgages sold between 1996–1998 have not always turned out to be products beneficial to the borrowers who took them out.
Sales and marketing About 12,000 shared appreciation mortgages were sold by Bank of Scotland between November 1996 and March 1998 (17 months), and 3,253 were sold by Barclays Bank between May and July 1998 (3 months). They were sold by Bank of Scotland through financial advisers and mortgage brokers, and by Barclays directly to the borrowers."Trapped in their own homes" by Paul Lewis, published in Saga Magazine, September 2006 Barclays Bank loaned a total of £98m of shared appreciation mortgages, and so the average size of each of their loans would have been about £30,126.
Barclays' booklet on shared appreciation mortgages says that they were "specially designed for the needs and lifestyles of the mature homeowner... aged 45 or over and... property worth over £60,000.""Shared Appreciation Mortgages" booklet published by Barclays Bank PLC, 1998 They were mostly aimed at people aged 65 and over, and marketed as ideal for people who had paid off their mortgage, allowing them to release cash tied up in their home without having to sell up.Published in Which? magazine, August 2003
In 2014, nearly half of the shared appreciation mortgages were still active.The SAM scandal – BBC Inside Out South by Nick Wallis, published in his blog on 15 September 2014, retrieved 6 February 2018
The loan and the repayment The lender of a shared appreciation mortgage lent a sum of money up to a maximum of 25% of the value of the property. The borrower retained ownership of the property and no repayments were made until the property was sold or the borrower died. At that time the repayment was the original amount borrowed plus a share of the increase in the value of the property. The lender's percentage share was three times the percentage of the value of the property that was originally borrowed. Therefore if the original loan was 25% of the value of the property, the share of the increase in the value would have been 75%. For the purpose of this calculation, the final value of the property was not the price at which the property was sold, but a valuation commissioned by the lender and paid for by the borrower.Annual Mortgage Statement dated April 2017 from Barclays Mortgages So if the property was sold for less than the valuation, the borrower's percentage share would be further reduced.
Barclays' booklet on shared appreciation mortgages gives an example of a property with an original valuation of £100,000 and a final valuation of £150,000. For a loan of £25,000, i.e. 25% of the original valuation, the repayment would be £25,000 + (75% × £50,000) = £62,500, i.e. 42% of the final valuation. Over a period of 20 years this would be equivalent to a compound interest rate of 4.7%.
However, the value of property has increased by a much greater amount than Barclays used in their example. The final valuation of the property in the example might now be £400,000. For a loan of £25,000, the repayment would be £25,000 + (75% × £300,000) = £250,000, i.e. 62.5% of the final valuation. Over a period of 20 years this would be equivalent to a compound interest rate of 12.2%, two and a half times the rate of the example. The borrower's share of the equity would be £150,000, less than half of the final valuation of the property of £400,000.
Bank of Scotland also sold shared-appreciation mortgages on which interest was charged at about 5.75% to 6% per annum. On these mortgages the maximum loan was 75% of the value of the property (compared with 25% for a zero-interest SAM), and the lender's percentage share of the appreciation was the same as the percentage ratio of the loan to the original value of the property (compared with three times the percentage for a zero-interest SAM)."Managing Innovation, Design and Creativity" by Dr Bettina von Stamm, published by John Wiley & Sons Ltd, 2003, Chapter 23: "Innovation in Financial Services, Case study 8: Shared Appreciation Mortgage – Bank of Scotland" Therefore if the loan was 75% of the original value of the property, the lender's share of the appreciation would also have been 75%. The interest was paid by monthly instalments, and the final repayment was the original amount borrowed plus the lender's share of the appreciation.
The large repayment amount of a shared appreciation mortgage and the small share of the equity remaining mean that the borrower might not have sufficient money to be able to downsize to a smaller property. The borrower would have less money to pay care home fees, which would require the local authority to make a greater contribution to those fees. And the borrower would have less money to leave to his or her children or grandchildren, some of whom might have been looking after the borrower for many years.
Conversely, in the unlikely event that the value of property had remained the same or reduced, the shared appreciation mortgage would have effectively been interest-free.
Interest rate formula To calculate the equivalent compound interest rate of a "zero-interest" shared-appreciation mortgage, i.e. the rate of the interest that would have been charged once a month on the amount owing, and added to the amount owing, so that at the end of the term of the loan, the amount owing would be the same as the repayment owing on a shared-appreciation mortgage:
which is the same as:
where is the amount of the repayment, is the amount of the loan, and is the time in years (and part of a year) between the loan and the repayment. The formula gives the equivalent compound interest rate of the mortgage as a percentage.
Alternatively, if it was assumed that the interest would have been charged once a year on the amount owing, and added to the amount owing, the formula would be:
which is the same as:
For loans that were 25% of the value of the property, the repayment would normally be 75% of the difference between the initial and final values of the property, plus the amount of the initial loan.
The origin of shared appreciation mortgages There is a detailed account of the origin of shared appreciation mortgages in chapter 23 of Dr Bettina von Stamm's book Managing Innovation, Design and Creativity, first edition published in 2003 and second edition published in 2008. Chapter 23 is titled "Innovation in Financial Services, Case Study 8: Shared Appreciation Mortgage – Bank of Scotland". This is a précis of the chapter:
The idea – rationale and getting buy-in Craig Corn, a director in structured finance at Merrill Lynch, was looking for a way to give investors access to one of the largest asset pools, the housing market. This was dominated by owner-occupiers, most of whose wealth was tied up in their homes. Meanwhile, commercial investment in the much smaller private rental sector of the market was hampered by the cost of managing rental property and the difficulty of gaining repossession. Linking an investment to a mortgage would give investors access to the much larger owner-occupier sector of the housing market and enable the owner-occupiers to make financial use of their asset.
As Merrill Lynch's management did not feel that the product would fit into their existing product portfolio, Craig Corn approached other companies, and moved to the Swiss Bank Corporation (SBC). David Garner had joined SBC from a building society in Autumn 1995, and had knowledge of the UK mortgage and capital markets. Corn and Garner worked together on the project and obtained legal opinion. It soon emerged that homeowners could give up a share in the appreciation of their property in return for a fixed-term, low-interest mortgage, while investors could access the shared appreciation in return for their investment. (SBC bought S. G. Warburg & Co., a leading British investment banking firm, in 1995, and merged it with its own investment banking unit to create SBC Warburg.)
As well as having the support of SBC as an investment bank, Corn and Garner also needed a mortgage lender to market and manage the mortgages. Of the building societies and banks they approached, Bank of Scotland had a good reputation and were considered to be innovative. In February 1996, Craig Corn contacted Willie Donald, who had recently joined Bank of Scotland as Director of Sales. Willie Donald liked the idea and took it via George While, Head of Mortgages, to George Mitchell, Divisional Chief Executive of Personal Banking, both of whom also liked the idea. Mitchell put the idea to the main board, who approved it in principle in June 1996.
Getting started SBC and Bank of Scotland quickly reached agreement to cooperate. George Mitchell selected Neil Forrest to work with Willie Donald on the product. Neil Forrest had been with the bank for seven or eight years and had expertise in securitization; Willie Donald had just introduced the Personal Choice Mortgage. According to Neil Forrest, Craig Corn and Willie Donald had the ideas while he and David Garner translated the ideas into something realizable.
The team spent four or five months working on the first version of the product, which did not involve securitization. This is the pooling of debt such as residential mortgages, and selling their cash flows as securities, also known as bonds. One reason that it had not initially been included was that it had a bad reputation: it was normally only used if direct financing could not be afforded. Another reason was that the proposed interest rate swaps would have been a substantial taxation risk for the bank. The second version of the product, which did involve securitization, was given the go-ahead.
The implementation team consisted of Willie Donald and Neil Forrest, responsible for the product, Ian Dickson and John Lloyd, for sales, John Trouten, for customer care, Dave Smith, for process area, and three people from systems. A second team was dedicated to develop the processes surrounding the shared appreciation mortgage. At the first implementation team meeting, on 25 September 1996, the launch date was set for 4 November 1996. Gary Gordon, Manager, Operations, joined the team in early October 1996.
Product and markets The team focused on a choice for borrowers of two interest rates: a 0% mortgage where the borrower could borrow up to 25% of the value of property and give up appreciation worth three times the percentage borrowed, i.e. up to 75%, and a 5.75% mortgage where the borrower could borrow up to 75% of the value of property and give up appreciation at the same percentage as the percentage borrowed.