This past July, Funding Partners originated the 1,000^thHouse to Home Ownership down payment assistance loan within the state, representing over $7.7 million in cumulative loan volume.  In light of program maturity and overwhelming popularity, the FP Board of Trustees has reaffirmed its commitment to delivering this valuable resource for first time buyers earning no more than 80% of Area Median Income.  As well, the mortgage finance industry continues to evolve, with secondary market players revisiting guidelines relative to subordinate financing vehicles.  With the confluence of such impetus, FP has elected to modify the structure of H2O loans to simplify the repayment formula, offer a generous incentive for early repayment and extend the loan term, as outlined below.    

Equity Sharing: When H2O was first introduced in 1999, the concept of Shared Equity Mortgages was somewhat foreign to the marketplace; readily accepted by certain mortgage lenders, though greeted with great skepticism by the majority of industry leaders.  To incorporate a repayment calculation more acceptable to the industry, H2O included an interest rate calculation that attempted to convert equity sharing into an interest rate that could be bracketed at the time of loan origination.  While this was accomplished in such a way that finance professionals could grasp and illustrate the formula for their clients, it is cumbersome and less precise than a pro rata division of equity at the time of loan payoff.  As the industry has evolved, the Shared Equity Mortgage model has attracted much wider support as an alternative to local policy initiatives that seek to control home values and limit the benefits of home ownership. Utilized in conjunction with community planning policies, the ESM model offers a valuable tool for mitigating the gap between personal income and prevailing housing costs that more closely reflects market dynamics.    

Old Policy – H2O  borrowers repay interest in lump sum.  The initial 2-year period carries a fixed rate of 3% with subsequent interest calculated according the annualized appreciation rate of the home, expressed as an interest rate percentage.  Minimum interest accrual is 3%, maximum is 11.5%.

New Policy– Eliminates the conversion of appreciation to an expressed rate of interest.  Rather, the borrower repays a pro rata share of equity appreciation (if any) based upon the percentage of the H2O loan to original purchase price.  Simply stated, if H2O represents 5% of original purchase price, the borrower would repay the original principal balance plus 5% of the equity gain at the time of loan repayment.  

Example:  Using the same scenario as above, the equity gain is $40,000.  Borrower would repay $40,000 x 5% or $2,000.

It is important to note certain nuances inherent to both models, collectively and individually, including:  Interest is a deductible expense to the borrower for the tax year in which it is paid.  Converting appreciation to an applicable interest rate provides such benefit, while a true equity share formula does not constitute a deductible expense, but rather a reduction of capital gains.  As it is difficult to conceive any situation in which an H2O borrower would approach the current capital gains exemption for a primary residence ($250,000 individual; $500,000 joint filing), the preferred method diminishes value to the borrower equal to their marginal tax rate, plus or minus repayment amount differential. 

In the example used above, the borrower repays a higher amount that grows exponentially in a rising market environment.  Conversely, the borrower would repay principal only or slight premium in an environment where values are relatively flat or depreciating.  Under either policy, capital improvements to the home and initial borrower investment are not considered due to the subjective nature of assessing market value of discreet improvements and limited borrower investment requirements under the program. 

Loan Term:        While the current loan term appears more than adequate, the secondary market prefers a longer maturity to minimize potential impacts to the primary mortgage instrument should a borrower be forced to pay a lump sum, while simultaneously remain current with all other obligations.  All H2O loans are repaid in lump sum only upon sale of the home, refinance of prior lien mortgages, event of default as defined within prior lien instruments, or discontinuation as owner occupant of the home, whichever occurs first.  Such repayment provisions are not affected by this program change.

Old Policy – Loan term is 10 years.

New Policy – Loan term is extended to 15 years.

Early Repayment Incentive:           A strategic advantage to program capitalization is the incentive provided to borrowers that are able to repay the loan within 24 months of purchase.  As well, the existing early repayment incentive has proven to be an excellent motivator for H2O borrowers to establish a personal savings habit.  As mentioned below, the interest rate at which H2O principal accrues adjusts from 3% to the appreciation rate, thereby triggering a ‘deadline’ mentality.  Pay early at a very low rate, or share ‘profits’ later.  Experience has demonstrated this structure has a positive effect, as the program enjoys an average loan term of roughly 2 years. 

Old Policy – Through the initial 24-month period of the H2O loan, interest accrues at 3% simple interest before adjusting to the calculated annualized appreciation rate through the duration of the loan term.

New Policy – Loans repaid in full within the initial 24-month period will include loan principal only.  Repayments that occur thereafter will include loan principal plus a pro rata share of recognized appreciation, as described above.  This may stimulate even greater desire to begin a personal savings program as equity sharing would begin immediately, rather than a low-interest teaser period.