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Shared Appreciation Mortgages: Lessons from the UK

The recent rise in shared appreciation mortgage (SAM) availability motivates
careful consideration of underlying borrower incentives. The lender's share
of appreciation in SAMs (share) is essentially a dynamic prepayment penalty
imposed on the borrower. However, the borrower faces a moral hazard
due to his ability to affect the penalty by reducing maintenance.

We adapt a competing risks mortgage-pricing model to calculate SAM
theoretical equilibrium rates. Our borrower possesses rational expectations
of both the house price market and interest rates. Our simulation results may
help explain the lack of secondary market interest for the UK SAMs containing
extreme contract terms.

Shared appreciation, mortgage pricing, options, prepayment penalty, default

JEL Classifications: G21

Sanders, Anthony B. and Slawson Jr., V. Carlos,
"Shared Appreciation Mortgages: Lessons from the UK" (July 2005).
Available at SSRN.

See also:

In a nutshell, the shared appreciation mortgage allowed you to
borrow 25 per cent of the value of your property at zero interest,
provided you agreed to pay the bank, upon your death or sale of
the house, 75 per cent of the appreciation in the price.

The punters were offered the benefit of a zero- interest-rate
mortgage; they took a risk; they got spectacularly stung.

-- Boris Johnson


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