Study Finds Shared-Equity Mortgages Could Enhance Housing Affordability, Increase Homeownership, and Improve Sustainability and Credit Quality of Mortgage Loans

Andrew Caplin, a professor of economics in NYU’s Faculty of Arts and Science, has co-authored a report which demonstrates the viability of a new mortgage product called the shared-equity mortgage (SEM). The study shows that — unlike adjustable rate mortgages, interest-only mortgages, or negative amortization debt instruments, which improve affordability at the expense of substantially increased borrower risk — SEMs reduce borrower risk. He and his co-authors conclude that this mortgage product could substantially enhance housing affordability and propel further advances in homeownership.

The study - “Shared Equity Mortgages, Housing Affordability, and Homeownership” - was funded by and conducted in partnership with the Fannie Mae Foundation. In addition to Caplin, the authors of the report include: James H. Carr, senior vice president and head of research for the Fannie Mae Foundation; Frederick Pollock, a vice president at Morgan Stanley; Zhong Yi Tong, director of housing affordability at the Fannie Mae Foundation; Kheng Mei Tan, who was a research assistant at the Fannie Mae Foundation; and Trivikraman Thampy, a PhD. candidate in economics at NYU.

An “expert chat” on the topic of shared-equity mortgages will be hosted on on Tuesday, April 24 at 2:00 p.m. EDT. Robert Shiller, a professor of economics at Yale and chief economist of MacroMarkets, LLC who was not involved in the report, will participate in the expert chat.

Caplin, co-director of the Center for Experimental Social Science at New York University, said, “By agreeing to share the appreciating value of their homes with investors, borrowers using SEMs simultaneously reduce their home-buying costs and lower their financial vulnerability, thereby enhancing the stability of the housing finance system. The introduction of SEMs would create a new asset class for investors, in addition to a new source of financing for homebuyers”

James H. Carr, a co-author and senior vice president and head of research for the Fannie Mae Foundation, pointed to the comparison with other recent mortgage innovations.

“As the massive problems of the sub-prime market make clear, Americans struggling to afford homes urgently need mortgages that will cut their costs without increasing their financial vulnerability,” he said. “SEMs are a novel and optimal solution since they allow lenders and investors to share more directly in both the risks and the rewards of home ownership.”

The study found that as a significant innovation in mortgage product design, the introduction of SEMs would require changes to the regulatory structure of certain rules relating to the U.S. mortgage market. However, the study’s co-authors believe that the limits of debt financing to improve affordability, as reflected in the current wave of rising defaults and foreclosures on homes financed with exotic features to stretch affordability, would create openness to the introduction of SEMs.

Key Research Findings:

  • There is little prospect of policy makers supporting costly new schemes aimed at expanding the rate of homeownership. So it has been left to private sector financial innovation to produce the new mortgages, such as interest only and negatively amortizing mortgages, which have driven recent increases in the ownership rate. Unfortunately these mortgages leave borrowers, lenders, and the broader financial system exposed to significant risk as demonstrated by the sub-prime crisis that is taking place at the present. At the same time, rising house prices have left many new entrants to the housing market with sharp, and steadily worsening, affordability problems.
  • With shared-equity mortgages, however, homebuyers could gain a new source of funding to buy home without an increase in their monthly mortgage payments. No payment is required during the term of the SEM loan. Yet the amount due at termination corresponds to a share in the value of the home that increases the longer the loan has been outstanding. The rate of growth in this share is called the shared-equity rate on the SEM in question: a typical annual rate is likely to be in the 3- to 4-percent range. The dollar amount due upon termination is determined by multiplying together the share of the loan due and the value of the house.
  • With a 4 percent shared-equity rate, a borrower who takes out a SEM loan for 20 percent of the home value owes 20.8 percent at the end of one year, and 29.6 per cent at the end of 10 years. Consider the $100,000 SEM loan on these terms for 20% of the cost of a $500,000 house. To pay off this loan at the end of ten years with a house price of $1,000,000 would require a terminal payment of $296,000, or 29.6 percent of $1,000,000. The shared-equity rate pricing mechanism of SEMs clearly provides stable investor returns while also providing borrowers with a predictable and transparent cost of capital.
  • For investors, simulations indicate that SEMs would add valuable new diversification possibilities. Moreover SEMs pose less risk to the financial system than do interest-only and negatively amortizing mortgages. A borrower taking out a 90 percent loan with a combination of a SEM and a regular mortgage has lower default risk than one who uses only regular mortgage finance. As a result, SEM finance would not only lower the risk of borrower default, but also enhance the stability of the broader financial system.
  • To explore the interest of prospective homebuyers in this new product, a household survey was conducted in 10 major metropolitan areas (Atlanta, Boston, Chicago, Los Angeles, Miami, New York, Philadelphia, San Diego, San Francisco, and Washington, D.C.). More than 1,500 completed responses to an Internet Survey were received during February 2006. The overall level of interest was high, particularly among renters facing either a pressing need to move (a new child, for example) or expecting improved circumstances in the near future.
  • Given this high level of interest in SEMs among renters, it is estimated that the introduction of SEMs would produce an increase of between 1 percent and 1.5 percent in the U.S. homeownership rate.

Frederick Pollock, a co-author of the report and a vice president at Morgan Stanley, said, “Corporations and financiers make use of a blend of debt and equity finance. It is therefore striking that individuals only have pure debt options available when financing a home. SEMs would introduce to consumers the same choice that corporations have for a long time and also reduce borrowers’ financial fragility by shifting risk to the financial sector.”

Zhong Yi Tong, another co-author of the research and director of housing affordability at the Fannie Mae Foundation, said, “An important use of the new SEMs would be to speed up renters’ transitions to ownership, thus helping them to participate in the price appreciation and wealth-building without delays. Public subsidies for home-buyer assistance clearly have their limits in both scale and efficacy, and exotic mortgages are having a devastating effect on both borrowers and economy. Now is the time to research what the true next wave of financial innovations is for affordable homeownership in this country. This research shows that shared-equity mortgages are just such a product.”

Much of the research that underlies the report was conducted under a grant from the Fannie Mae Foundation to Caplin and NYU. In addition to his long-standing academic interest in shared equity mortgages, Caplin is now participating commercially in their launch via a shareholding interest in PCM Asset Management Corporation, in which NYU also has a shareholding interest.

The full report, including an executive summary, may be viewed as a downloadable PDF at The research report will also appear at the Housing Policy Debate (volume 18, issue 1).

STYLE USAGE: The Fannie Mae Foundation is a separate legal entity from Fannie Mae (a NYSE-listed company). In order to facilitate clarity and avoid confusion, news organizations are asked to refer to the Foundation exclusively as “the Fannie Mae Foundation” or “the Foundation,” but not as “Fannie Mae.”

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